SNDL - Earnings Call - Q1 2025

Transcript

Operator (participant)

Morning, and welcome to SNDL's first quarter 2025 financial results conference call. This morning, SNDL issued a press release announcing their financial results for the 2025 first quarter ended on March 31st, 2025. This press release is available on the company's website at sndl.com and filed on EDGAR and SEDAR as well. The webcast replay of the conference call will also be available on the sndl.com website. SNDL has also posted a supplemental investor presentation in addition to the conference call presentation we will be reviewing today on its sndl.com website. Presenting on this morning's call, we have Zach George, Chief Executive Officer, and Alberto Paredero, Chief Financial Officer. Before we start, I would like to remind investors that certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated.

Risk factors that could affect results are detailed in the company's financial reports and other public filings that are made available on SEDAR and EDGAR. Additionally, all financial figures mentioned are in Canadian Dollars unless otherwise indicated. We will now make prepared remarks, and then we'll move on to the analyst questions. I would now like to turn the call over to Zach George. Please go ahead.

Zach George (CEO)

Good morning, and welcome to SNDL's Q1 2025 financial and operational results conference call. We are pleased to see that during the first quarter of 2025, we continue to break new records, making further progress in operational and efficiency improvements and achieving success with our cannabis business. Our cannabis segments continue to show strong momentum, achieving steady year-on-year revenue gains for the 13th consecutive quarter. We continue growing well above the market average, not only thanks to our strategic inorganic investments, but also due to a winning formula that drives organic growth ahead of the market. Achieving a new all-time high gross margin record of 27.6% in a quarter affected by lower revenue seasonality leverage was particularly inspiring. We are very pleased with how our teams consistently raised the bar, executing well-planned productivity initiatives and efficiency improvements across all areas of our business.

We are particularly encouraged by the progress made integrating the accretive Indiva business while identifying additional synergies that exceed our initial estimates, laying the foundation for further improvements in the coming quarters. Free cash flow was marginally negative at CAD -1 million. Despite seasonal pressures from the year's lowest revenue quarter and the need to rebuild inventory levels following the holiday demand peak, these improvements in cash generation are underpinned by ongoing operational enhancements and disciplined work in capital management. Delivering quarterly financial performance improvements and reliability is crucial to us. We owe this to our shareholders, our partners, and ourselves. However, our work does not end there. Unlike many other players in the industry, our strong balance sheet enables us to focus on building robust long-term strategic foundations.

In recent months, we announced additional share buybacks, acquired a minority stake in High Tide, and announced the arrangement agreement to acquire 32 cannabis retail stores from 1CM. Today, we're announcing that our Board of Directors has initiated a formal strategic review to evaluate SNDL's exposure to U.S. multi-state licensed cannabis enterprises and our current exchange listing status. I would like to elaborate further on this last point. We are in a unique position within our industry, which allows us to take the driver's seat when exploring additional strategic corporate transactions. We possess both the capability and expertise to successfully close a variety of opportunities, giving us the flexibility to pursue alternative strategic paths. On an ongoing basis, we diligently review numerous opportunities on both sides of the border with the overarching objective of maximizing shareholder value.

For this reason, the board is evaluating whether to maintain our current equity market listings, which restrict us from operating U.S. assets, or transition to an alternative structure that would grant us the regulatory flexibility to actively manage a broader North American cannabis platform. This shift could potentially enable the consolidation of licensed cannabis businesses across multiple U.S. states. I want to make clear that while we have begun exploring various options, no conclusions have been reached and no decisions have been made. There is no assurance that any transaction or listing change will result from the strategic review. The company does not intend to provide further updates unless or until the board approves a specific course of action or determines that additional disclosure is warranted. Moving back to our short-term results, I want to hand the call over to Alberto for more insights on our first quarter financial performance.

Alberto Paredero (CFO)

Thank you, Zach. Our team is prouder than ever to showcase the operational progress we continue to make. Let's move on to our first quarter financial highlights. I want to remind everyone that the amounts discussed today are denominated in Canadian Dollars unless otherwise stated. Certain figures referred to during this call are non-GAAP and non-IFRS measures. For definitions of these measures, please refer to SNDL's Management Discussion and Analysis Document. We continue to see improvements year-over-year in net revenue, gross profit, gross margin, and free cash flow. Net revenue in the first quarter of 2025 reached CAD 205 million, a 3.6% increase compared to Q1 of last year. This was driven by a combined cannabis business growth of 16.8%, which included contributions from our recent Indiva acquisition, partly offset by declines in our liquor retail segment.

Gross profit of CAD 56.6 million reflects a CAD 6.2 million increase, or 12.4% growth year-over-year, resulting in 220 basis points improvement in gross margin. This translates to another quarter of record gross margin reaching 27.6%. Adjusted operating income for the quarter amounted to CAD -9 million, partially impacted by a loss of CAD 4.5 million from the SunStream portfolio, driven by a negative valuation adjustment as a consequence of the reduction in the bond market price of cannabis. Year-over-year, we see a decline of CAD 4.6 million as the negative adjustment from the SunStream portfolio in 2025 compares to a +1 of CAD 9.1 million in 2024. This creates a swing of CAD 13.6 million year-over-year from the SunStream portfolio that was partially offset by ongoing operational improvements.

Free cash flow was marginally negative for the quarter at CAD 1.1 million, despite seasonal impacts on revenue and the associated build-up of working capital, representing an improvement from the same quarter of 2024. Our historical quarterly performance evolution shows a clear upward trend, indicative of our continuous focus on growth and efficiency improvements. The only anomaly is the adjusted operating income impacted by the SunStream portfolio value adjustment, just as just explained. Looking at the contributions from each segment across our main financial KPIs, we notice how the net revenue decline in liquor is impacting the overall consolidated results, despite the strong growth from both cannabis segments. The revenue elimination from cannabis is related to the sales from the cannabis operations segment into our own retail. This elimination is increasing as a result of our cannabis business growth.

In terms of gross profit, liquor retail shows a small decline in the first quarter as a result of the lower revenue. Cannabis retail, and particularly cannabis operations, continue to drive increases in gross profit, with contributions of CAD 1.3 million and CAD 6 million respectively. Adjusted operating income shows the improvement from our operating and corporate segments, being offset by the year-over-year impact of the SunStream valuation, which was positive in 2024 and negative in 2025. Free cash flow for the first quarter of 2025 remains marginally negative at CAD -1.1 million. However, this represents a CAD 5.3 million improvement compared to the same period in the previous year, primarily driven by enhanced earnings and working capital management. Examining the year-over-year drivers of free cash flow in greater detail, we observe that the change in SunStream valuation impacts net income but is reversed through non-cash add-backs.

Inventory changes in the first quarter remain consistent with the prior year, while improvements in other working capital are primarily driven by accounts payable. Additionally, capital in the first quarter is slightly lower compared to the previous year. Nearing free cash flow break-even in the first quarter is encouraging, especially considering the seasonality of our business, which consistently drives stronger cash flows in the second half of the year. Focusing on our operating segments, liquor retail recorded net revenue of CAD 109.5 million in the first quarter, reflecting a reduction of CAD 6.6 million or a 5.7% decline. Compared to the prior year, this quarter was impacted by one less day in February and the shift in Easter timing, which contributed to an unfavorable impact of approximately 4 percentage points.

As a result, the normalized underlying revenue decline for the quarter is closer to 2%, representing a slight improvement compared to the trends observed last year. Despite the net revenue decline, the gross profit reduction was mitigated by an improved gross margin, which reached 25.4%, a 60 basis point increase compared to Q1 of the previous year. Operating income of CAD 2 million shows a marginal decline compared to the prior year, as the reduction in SG&A expenses was offset by the lower gross profit, as well as the lapping of a CAD 0.9 million impairment reversal from the prior year. Cannabis retail delivers strong financial performance in both top and bottom lines, despite being impacted by one fewer working day and the shift in Easter timing. Net revenue for Q1 2025 reached CAD 77.5 million, an 8.7% increase compared to the prior year.

This growth was primarily driven by a 5.2% increase in same-store sales and contributions from new all-store openings. The revenue growth supported a CAD 1.3 million increase in gross profit, despite a 40 basis points decline in gross margin compared to the same period last year. However, this represents an improvement in the gross margin trend, as the 25.3% reported for Q1 2025 exceeds both the average margin and the exit margin of 2024. Both adjusted and unadjusted operating income rose by over CAD 6 million year-over-year, reaching CAD 5.2 million in Q1 2025. This improvement was driven by revenue growth and enhanced SG&A efficiency, while benefiting from lapping a fixed asset impairment reported in Q1 of the previous year. Our cannabis operations segment continued to deliver the largest P&L improvements.

Net revenue for the first quarter of 2025 was CAD 34.3 million, reflecting an CAD 11.9 million or 53% growth compared to the prior year. This includes a CAD 10.2 million contribution from Indiva. Gross profit achieved a significant increase compared to the prior year, driven by a 12.4 percentage point expansion in gross margin, which reached 26.8%. These improvements are mainly driven by our productivity program and initial synergies from the Indiva acquisition. Adjusted operating income for the first quarter came in at a CAD +2.4 million, marking a CAD 1.3 million improvement year-over-year. This growth was achieved despite lapping a CAD 1.8 million bad debt reversal reported in the first quarter of 2024. Now, I will hand it over to Zach for additional insights into our strategic priorities.

Zach George (CEO)

Thank you, Alberto. As expected, during 2025, we remain focused on our three strategic pillars, which are essential to our long-term success: growth, profitability, and people. Starting with growth, our cannabis retail segment is outperforming the market. As previously mentioned, this segment reported net revenue growth of 8.7% in the first quarter of 2025, significantly ahead of the market. Our performance is bolstered by strong same-store sales growth of 5.2% during the period, reflecting not only excellence in execution, but more importantly, the trust our consumers continue to place in us. The combination of robust same-store sales growth and new store openings has resulted in an additional 0.3 percentage points of year-on-year market share gains. The acquisition of 1CM, announced after the quarter's end, is not only another key milestone but also demonstrates our strategic commitment to expanding our cannabis retail footprint.

We anticipate closing this transaction by the end of the third quarter. We are enthusiastic about this acquisition, not only for the exposure it provides to new store formats and shopper insights, but also for its potential to drive substantial incremental organic growth. Our cannabis operations segment posted a strong 53% revenue growth in the first quarter as we continue gaining distribution points and leveraging the incremental platform provided by the acquisition of Indiva during the fourth quarter of 2024. Under our profitability priority, we are pleased to report continued improvements in free cash flow generation, specifically CAD 5.3 million better than the same quarter in 2024. This progress is driven by contributions from both income growth and effective working capital management.

Incremental productivity improvements of CAD 3 million during Q1, primarily from our cannabis operations segment through procurement, manufacturing, and cultivation efficiencies, have contributed to the new gross margin record previously mentioned. Data licensing revenue contributed another CAD 4.5 million in the quarter, further supporting gross margin expansion. We also achieved CAD 4 million in overhead savings in Q1, driven primarily by the results of the restructuring program that was announced last July. On this last point, the restructuring program continues to be executed according to plan, delivering CAD 4 million in savings during the first quarter. This achievement corresponds to an annualized run rate of CAD 17 million, or 85% of our planned target.

Last but not least, our people remain our greatest competitive advantage, and we are committed to continuing investment in their development while creating a work environment that fosters engagement and enables all team members to contribute and grow to their full potential. Under our strategic talent development process, we are pleased with the progress and enhancements made to our annual performance review cycle. This initiative gave our organization an opportunity to step back and both individually and collectively reflect on what we did well during the year and the lessons we learned to help us raise the bar in the future. This is a key component of our continuous improvement mindset. Following the engagement survey conducted in the fourth quarter of 2024, we hosted several focus groups with our teams to develop actionable strategies targeting the biggest opportunities to further enhance our employee experience and engagement.

During the quarter, we successfully transitioned all legacy Indiva employees to our consolidated HR platform, facilitating the seamless integration of this business into the SNDL family. Finally, we received very positive feedback from our employees regarding the distribution of an annual total compensation letter. This letter summarizes the individual compensation components achieved during 2024, along with merit adjustments and incentive targets for 2025. This initiative aligns employee incentives with both individual contributions and overall company performance, while also showcasing the competitiveness of our total compensation philosophy. As we conclude, I would like to take a moment to reflect on the progress our team has made. We continue to seize new opportunities, tackling challenges head-on while laying down a strong foundation for the future. We are thrilled with this progress and remain confident in our ability to successfully navigate the complexities of our industry.

Once again, I would like to thank our entire team for their contributions and our shareholders for their continued trust. I will now hand the call back to the operator for the analyst Q&A session.

Operator (participant)

Thank you. We will now begin the analyst question and answer session. To join the question queue, you may press star, then 1-1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your headset before pressing any keys. To withdraw your question, please press star, then 1-1 again. Our first question will come from Frederico Gomes with ATB Capital Markets. Your line is open.

Frederico Gomes (Analyst)

Thank you. Good morning. Thanks for taking my questions. Zach, maybe just speaking more broadly here, I guess if you indeed decide to enter the U.S. market directly, just curious, what's the strategy that you think would make sense here given the current state of the industry and what would be the differentiators that SNDL could bring to the U.S. market? What would be your competitive advantage and how you would plan to explore that? Thanks.

Zach George (CEO)

Good morning, Fred, and thanks for the question. Just as a preface, I just want to make clear that this decision is under review by our Board of Directors, so no decision has been made. To your question directly in terms of how would we enter and what would our competitive advantages be, please recall that we have two exposures through credit investments in our SunStream vehicle that are subject to current restructuring activity. We believe that those restructurings are going to be completed in the coming months. In terms of the notion of entering the United States, we have existing capital exposure with previously committed investments that would take us there. It is not as if we would be looking at some imminent large cash outlay or issuance of shares to do so.

Those enterprises are in existence today, and we do have exposure that would be converted from senior credit into a mix of equity and other instruments. In terms of a competitive advantage, look, the fact that we've lived through and weathered a very deep cycle in the federally legal Canadian landscape where we've seen overcapitalization, excess infrastructure buildout, which then drove massive oversupply in the market, and where even at the margin, the failure or lack of payment of excise taxes by certain companies was used to fund discounting behavior, which drove a very aggressive race to the bottom in terms of product pricing, which then in turn drove very challenging margin profiles for businesses up and down the supply chain. We believe that we've learned significantly from that cycle and developed strength and a skill set, which is very applicable in many different international markets, including the U.S..

State markets, which are in various states of play, as you know, in terms of being medical, recreational, or both. The discipline that we've had to learn in terms of labor management and everything from our real estate exposure to our state of automation in terms of manufacturing in our vertical model, it gives us a very clear view as to which strategies will be successful in markets outside of Canada. While it would be very difficult to say this in many other industries, in this specific case, I believe that the Canadian experience is actually a massive asset when ported to these other markets. Not only do we have the talent and we've built the capabilities, but we have the balance sheet and capital base to exploit these opportunities. Right now, we're considering this.

The board is working to make the right decision for the long term for shareholders, and we'll certainly update you and our investors when a decision is made.

Frederico Gomes (Analyst)

Thank you. Appreciate that. Second question on your cannabis retail platform. Just curious about the M&A outlook there. You obviously recently announced the acquisition of additional store there, but are you looking at making further acquisitions of a similar size? Do you have a good pipeline of opportunities in Canada for retail?

Zach George (CEO)

Yeah, I really appreciate the question. The answer is yes. While we are still focused internally on optimization, and we believe that we have quite a bit of running room in terms of margin improvement and free cash flow improvement, we are very active in terms of evaluating both organic and inorganic growth in our Canadian retail network. As we stated over the last several quarters, capital deployment to build out a dominant retail footprint is a top priority for our board and management team. That has not changed. Second to that, as we talked about, was the potential to invest in core markets in the U.S.. Just speaking maybe more specifically about opportunities, we are engaged and continue to receive unsolicited inbounds from certain parties that are retail operators in Canada. We are also still doing careful site work to position new door openings in key locations.

There are also a number of both sort of medium-sized and larger-scale portfolios that we are watching very carefully and engaged in constructive conversation. These things can take some time to come to fruition. Given the fact that we expect the 1CM transaction to close sometime late in Q3, we have a really important window to focus on internal improvement and efficiency while we await the sort of next leg of growth that should position us for a very strong Q4.

Frederico Gomes (Analyst)

Thank you. Just final question for me. Just if you could comment on the rollout of your loyalty program in retail, what is it that you expect to get out of that program? How can it help your operations, your margins, your sales, and your strategy in Canada? Thanks.

Zach George (CEO)

Do you want to answer?

Frederico Gomes (Analyst)

Yeah. Hi, Frederico. This is Alberto. Actually, we're very excited about the potential our loyalty program can offer, starting with giving us a platform to communicate effectively with our consumers and giving them as well the possibility to leverage a stronger value from their loyalty to us. In every purchase opportunity, they can certainly leverage that and be rewarded accordingly. I would say it's both the advantage that it provides to our consumers, particularly those that are the most loyal, as well as, as I said, an opportunity to create a direct communication channel with them and make sure that they understand what type of offers, promotional activity, or new product launches that we have in our retail locations. We have as well the potential, and we're actually working on expanding that loyalty program across our different banners.

That is not only within cannabis, but it has as well the potential to expand in our liquor network.

Great. Thank you very much. I'll go back to you.

Thank you, Fred.

Operator (participant)

Our next question will come from Yewon Kang with Canaccord. Your line is open.

Yewon Kang (Analyst)

Hi, good morning, and thank you for taking my question. Just one from me here. In recent days following the federal elections in Canada, there seems to have been a bit of a renewed sense of optimism towards the government implementing the set of regulatory recommendations that have been previously brought forth by the Standing Finance Committee, with obviously the most topical one being the recommended excise tax reform to move towards the 10% ad valorem rate. Could you share any insights on how you guys are thinking about the path towards this reform and if you believe that the ongoing trade war has any sort of impact on how the government is viewing the cannabis industry? Thanks.

Zach George (CEO)

Good morning, and thank you so much for the question. It's a great question. Look, I would say that we don't want to go too far beyond cautious optimism. I think excise reform has been obviously a really hot topic for Canadian operators. We're not convinced that material change is going to happen in the near term. I would say that we are seeing some degree of very positive and constructive regulatory reform, whether you're looking at some of the retail regulations across provinces, packaging restrictions. We also expect milligram limits on edibles to shift this year, which will likely be a boon for that category. We are seeing important marginal reform that's happening.

The notion that we are months away from all seeing excise tax rates drop and that this will be some big boon for the industry, we're not quite prepared to make that call just yet. No other particular insights beyond what you're hearing and reading in the industry and media today. In terms of trade disputes, not going to put words in Mark Carney's mouth, so to speak. I think he's got a number of priorities that are seen as significantly more important than the CAD 5+ billion cannabis industry in Canada. I'm sure that the liberal government will continue with many of the same approaches and policies that it has in previous administrations.

Importantly, when you reference the trade war, I think gratuitously I should just mention that we are not expecting or experiencing any material disruption in our business from this dueling and uncertain tariff dynamic that's in play. Our real exposure there, we had approximately 5% of sales in our liquor business coming from U.S. products. When you look at products like Kentucky bourbon, for example, you may see shifts in terms of presence on shelf in the Canadian landscape. We were also in the midst of working towards very new and expanded private label options to better reach consumers and deliver value. This is in no way sort of an excuse for our teams or leadership in terms of performance.

On the cannabis side, there are some modest exposures through potential inflation dynamics with packaging specifically, but we do not see that having a material impact on the business that would result in materially impaired margins or anything like that. As an industry, particularly being based in Canada, we are going to fare reasonably well relative to many others in terms of potential disruption from trade-related disputes.

Yewon Kang (Analyst)

Thank you.

Operator (participant)

Once again, if you have a question, please press star, then 1-1. This concludes the question and answer session. I would like to turn the conference back over to Zach George for any closing remarks.

Zach George (CEO)

Thank you, Michelle, and thank you all for joining us today. We appreciate your time and look forward to updating you on our progress in the near future. Thank you.

Operator (participant)

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.