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Edited Transcript of SNDL.OQ earnings conference call or presentation 13-Nov-19 10:00pm GMT

Q3 2019 Sundial Growers Inc Earnings Call

Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Sundial Growers Inc earnings conference call or presentation Wednesday, November 13, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Stordeur

Sundial Growers Inc. - President of Canada

* James Keough

Sundial Growers Inc. - CFO

* Jayson Moss

Sundial Growers Inc. - Executive of IR

* Louise Motala

Sundial Growers Inc. - MD of Sundial UK

* Ryan Hellard

Sundial Growers Inc. - Chief Experience Officer

* Torsten Kuenzlen

Sundial Growers Inc. - CEO & Director

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Conference Call Participants

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* Douglas Miehm

RBC Capital Markets, Research Division - Analyst

* John Zamparo

CIBC Capital Markets, Research Division - Associate

* Steven Jason Schneiderman

Cowen and Company, LLC, Research Division - Research Associate

* Tamy Chen

BMO Capital Markets Equity Research - Analyst

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the Sundial Growers Inc. Third Quarter 2019 Results Conference Call and Webcast.

(Operator Instructions) And the conference is being recorded. (Operator Instructions) I would now like to turn the conference over to Jayson Moss, Investor Relations, Sundial Growers. Please go ahead, Mr. Moss.

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Jayson Moss, Sundial Growers Inc. - Executive of IR [2]

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Good afternoon, and welcome to Sundial Growers Third Quarter 2019 Financial Results Conference Call. This afternoon, we issued a press release announcing our financial results for the third quarter 2019 ended September 30, 2019. This press release is available on our website, sndlgroup.com, and filed on EDGAR and SEDAR as well.

Presenting on this afternoon's call, we have Torsten Kuenzlen, Chief Executive Officer of Sundial; and Jim Keough, Chief Financial Officer of Sundial. Also joining us on the call will be Andrew Stordeur, President of Canadian operations; Ryan Hellard, Chief Experience Officer; and Louise Motala, Managing Director, Sundial U.K., to answer any questions if needed.

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.

Following prepared remarks by Mr. Kuenzlen and Mr. Keough, the company will conduct a question-and-answer session, during which questions will be taken from analysts.

I would now like to turn the call over to Torsten Kuenzlen.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [3]

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Thank you, Jayson. And good afternoon or evening, everyone, depending on where you are. As the newest public Canadian cannabis company, we realized over the last 4 months since our IPO, that the awareness and understanding of Sundial still lags far behind that of our longer established competitors.

Before, therefore, diving into the details of our progress, specifically in quarter 3, I want to take a few minutes to frame our company for everyone in a broader context. We have obviously made tremendous progress in our relatively short history. From our current creation of Sundial in its current form in January of last year, Sundial has rapidly grown into one of the largest international cannabis producers in less than 2 years. We are aggressively and successfully competing in the Canadian and international priority opportunity spaces, which we call Heal, Help and Play. Heal is the medical cannabis opportunity requiring a prescription, Help is the health and wellness opportunity often too narrowly defined as CBD, and Play is what we call the federally legal recreational cannabis opportunity. With annual production capacity of up to 100 million grams in our state of the art facilities in Canada in calendar year 2020 and a further 2.4 million square feet of cultivation space in our new European operation, we are achieving a production scale that rivals or already exceeds most of our competitors. More importantly, our purpose-built fully controlled modular indoor facilities in Canada can produce premium cannabis at a quality, consistency and agility which truly sets Sundial apart. Our unique crafted scale approach strongly differentiates us in the Canadian market.

Having only recorded marginal initial sales in quarter 1 of this year, our sales of almost 8,000 kilograms and actual cannabis revenue in Canada in quarter 3 of over $28 million also puts us firmly in the top-tier of Canadian cannabis companies. Importantly, we recorded organic quarter-on-quarter revenue growth of over 40% in quarter 3.

Consolidated Sundial revenue grew 74% as we started recording the revenue of our recent European Bridge Farm acquisition. This significant Canadian revenue ramp has been achieved despite slower than initially anticipated market size development due to the vastly insufficient number of retail outlets opened to date. This still allows the majority of cannabis in Canada to come from the illegal market 1 year after legalization. We are, however, confident that this will change rapidly in the second year of legalization, especially with the addition of the soon-to-be available Cannabis 2.0 format, which like vape and edibles, until now have only been available illegally.

In addition to building a great business in Canada across Heal, Help and Play, we're also making strong progress internationally. Most notable and already public information was our decisive acquisition of Bridge Farm, the leading agricultural indoor producer of ornamental flowers and edible herbs in the U.K. From early 2020, we will be cultivating in 2.4 million square feet of high quality, low-cost and environmentally friendly facilities, which are among the very best in the world.

The key driver that fuel Sundial's continued rapid progress and leadership position is our highly experienced and motivated team, from our Board to the front line, which manages the opportunities and challenges we face in the exciting new global cannabis industry. Our unique combination of international consumer packaged goods leaders and cannabis and cultivation veterans gives us the ability to quickly pivot as the industry evolves. This is true from our construction and growing to our processing, marketing sales, HR and finance teams. Our people truly are our competitive advantage.

With that as a backdrop, let me now turn your attention to our specific Q3 results and progress. We harvested almost 12 million grams of cannabis from 117 crops, up from 94 in the previous quarter. We sold approximately 8 million grams of cannabis, up 68% from Q2. We maintained very strong branded and unbranded flower margins and average selling prices. Consolidated net revenue of $33.5 million grew 74% or $14.2 million compared to quarter 2. This includes over 40% revenue growth quarter-over-quarter in our Canadian business and $5.5 million of international revenue as we start reporting our new U.K. business for the first time.

Consolidated adjusted EBITDA loss of $7.9 million, which Jim will talk more about later on. We also secured sufficient funding to complete our expansion plans in Canada and the U.K. as well as fund our business operations to self funding. These results were driven by the great strides we made operationally in the quarter. In Canada, we expanded our geographic footprint by entering the new retail markets of Ontario, Saskatchewan, Manitoba, Nova Scotia and British Columbia with an ever-increasing number of brands and products now available on shelves and online across the country. Our leading brand and product portfolio is enabled by the noticeably better cannabis grown in our crafted scale facilities. In the third quarter, we expanded from 2 to 3 commercial strains grown mostly for wholesale to growing 19 different premium strains, fueling our innovation pipeline to meet consumer needs as we increasingly focus on sales through provincial boards and retailers in our existing and new geographies.

The Sundial brand delivered solid performance from existing and new consumers, driven by successful product and package innovation as well as the aforementioned geographic expansion. All 4 Sundial products have strong repurchase intentions between 85% and 95%, with innovative premium quality offerings like Lemon Riot selling out as soon as they hit the market.

We also made further progress with construction of our sites in Olds, Alberta and Merritt, British Colombia. For our flagship facility in Olds, we are awaiting licensing approval of our further final 40 grow rooms and completion of our people and processing facility, which will allow us to in-source more activities like extraction for operational and financial efficiency.

Similarly, we are continuing to make progress in our new European state of the art [flagship] facility in Spalding, U.K. In addition to operationalizing more automation in the first phase of the facility, we are also rapidly approaching completion of our Phase 2 greenhouse, adding over 800,000 square feet of cultivation space for peak season demand in the spring of 2020 and giving us ample, highest quality cultivation space to grow hemp and cannabis for Heal, Help and Play as soon as possible.

Subsequent to quarter end, we also received our license from Health Canada for the sale of cannabis oil product, which will be available to consumers in early 2020. Our first product will be an unflavored CBD 20:1 oil that is part of Sundial's Ease product line in the Help segment. With the new license, along with the new formats, legalized in mid-October and beginning to be sold soon, the opportunity for Sundial to drive the development and launch of additional product formats including initially vapes, topicals and teas is tremendous. You can expect to see continued related announcements in the coming weeks and months.

Our topical products will benefit from the exclusive partnership with Crescita Therapeutics, which we announced last month. The partnership [is] development and licensing agreement that grants us the worldwide rights to Crescita's proprietary transdermal delivering technology for topicals containing cannabis and hemp. This agreement perfectly enables our strategy of providing superior consumer products in all desirable consumer formats. We expect to develop and market unique high-quality topicals for the Canadian and international over-the-counter markets, which apply across Heal, Help and Play over time.

We will also be leveraging our agreement and 50% interest in Pathway Rx, which we acquired in March. With Pathway's ability to screen an extensive library of cannabis strains to identify and customize treatments and benefits for a wide range of Heal, Help and Play product, including skin disorders, protection and rejuvenation, we have another competitive advantage to develop and market superior-branded innovations.

I want to conclude by touching on our corporate strategy and taking a look forward. Overall, our international premium CPG brand-driven strategy remains unchanged. We continue to have a focused and phased growth strategy in Canada and internationally. In Canada, we will further optimize capacity and calibrate operations for effectiveness and efficiency. A key driver here will be our flagship facility in Olds, where in addition to optimizing cultivation, we will integrate further processing with extraction and new format capabilities. We will also continue to build Phase 1 of our facility in Merritt, BC and optimally leverage our existing Rocky View facility.

We are maximizing the play opportunity with new brand and product offerings, including some proprietary new strains available shortly. We're particularly excited about the new formats and the related opportunities for Sundial to be a leader in the most important profitable new Cannabis 2.0 segments, led by vape. We're making great progress securing significant listings for vape and our other new products with boards across the country. Once again, the agility provided by our portfolio strategy and brand architectures to bring new product to Canadian consumers will increasingly be a competitive advantage as cannabis resembles other traditional consumer packaged goods categories more and more.

In Europe, we'll complete Phase 2 of our state of the art flagship facility to continue to grow our existing original plant business and enable our U.K., European and international Heal, Help and Play strategy, starting with CBD and other plant-based branded health products. We also plan to commercially exploit the large shield market in Canada and internationally as we begin to execute our differentiated multi-pronged strategy. We're excited about the IP we already have in partnership with Pathways and our plan to further develop and commercialize this.

Given recent market developments and to be expected, continued volatility in our new industry, we're working hard to make agility a key competitive advantage for Sundial. Every aspect of our business, starting with cultivation, is built for flexibility to adjust to market changes. Depending on market demand, we can manage production accordingly to constantly optimize demand fulfillment, inventory levels and cost. As already mentioned, we will increasingly be pivoting from our previous wholesale to much higher branded retail focus now that our facilities are capable to produce branded products at scale. Specifically, going forward, we will drive more branded sales through boards and retailers directly to consumers, focus on our strong product pipeline, including the new Cannabis 2.0 formats and many new in-demand premium strains. These premium strains and our CPG proven commercial capabilities are expected to drive step-change in consumer sales through coming quarters at high margins.

Keeping our U.K. business focused on the continued profitable expansion of the existing business, leveraging our significant additional capacity in early 2020, while building the legal local European and international plant-based wellness business, including CBD products. Proactively manage capital and debt by carefully balancing investments based on market opportunities with a clear focus on near-term sustainable profitability. Continue to balance strategic complexity with our capability to execute by focusing on doing a few key things very well instead of suboptimally pursuing too many opportunities.

Our midterm revenue and margin expansion will be driven by several key factors. The completion of construction activities at our Canadian and U.K. facilities will reduce operational inefficiencies and allow us to optimize every aspect of our operations for continued improvements to drive quality and reduce cost. Carefully aligning supply and demand by producing exactly what is required and carefully managing related costs and supply chains. Our sales mix will change significantly and positively as we expect up to 50% of our product being sold through the provincial board channels in multiple brands and product forms by the middle of 2020. This is up from only about 10% in Q3.

Simply put, we will sell as much high-margin branded cannabis as we can and profitably wholesale as much as we have to, to leverage our significant 2020 capacity.

With that, I will turn the call over to Jim and then come back for some quick concluding remarks.

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James Keough, Sundial Growers Inc. - CFO [4]

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Thank you, Torsten, and good afternoon, everyone. Before I kick off my remarks, please be reminded that my remarks are in Canadian dollars, unless otherwise noted, and the comparative quarter is Q2 2019, unless otherwise stated. As Torsten mentioned, we've come a very long way in only a few quarters, and our results underscore our ability to remain agile in an evolving marketplace. Sundial currently has 2 geographical business units: one is cannabis, grown in Canada and currently serving the Canadian market; the other is our U.K. ornamental flower business, with the acquisition of Bridge Farm in July of this year, to be the center of our low-cost-at-scale production of ornamental flowers and herbs and eventually CBD products. This is our gateway to European and global markets as we establish our international strategy.

These segments have different revenue and margin profiles, so while I speak to consolidated results at the beginning of my remarks, I'll quickly move to speaking to these 2 business segments. First, consolidated results. We delivered net revenue of $33.5 million, which translates into growth of 74%, driven by over 40% growth in our core Canadian cannabis sales and the expansion into the U.K. with the acquisition of Bridge Farm. While we continue to significantly increase sales in the quarter, we were impacted by certain onetime costs and the gross margin impact from our decisive action to manage inventory levels that affected the adjusted EBITDA.

G&A expense increased this quarter to $14.6 million, mainly due to additional costs associated with the transition to becoming a public company. For example, legal and accounting expenses, D&O insurance, listing fees and SOC certification-related activities. We also saw an increase in employee-related costs as we ramp up our operations, including -- expense associated with the build-out of our facilities. We expect employee-related costs to level out as we move forward. There was also expense associated with the integration of our U.K. business. The increase in G&A largely drove our overall increase in operating expense, although we also had a moderate increase in sales and marketing expenses. As we move forward, we plan to manage and flex our cost structure.

In our Canadian operations, we have specific strategies to reduce cost, including eliminating temporary labor, which will save over $800,000 per month. Conversion from temporary diesel-generated power to permanent grid power, which is a difference of over $6 million incurred year-to-date and flexing our operations into production capacity to match sales. We expect to grow expenses at a slower rate than sales and as a result, decrease cost on a relative basis over time.

Our Q3 adjusted EBITDA approached breakeven when we factor in a number of costs with a onetime occurrence or magnitude such as IPO-related employee costs; gross margin impact from the proactive management of inventory levels; adjustments to Health Canada fees; destruction of control samples, which were determined to be unsalable; integration of Bridge Farm operations; and the implementation of ERP and HRIS systems.

Our reported adjusted EBITDA was a loss of $7.9 million. Our net loss for Q3 was $97.5 million. While we do focus on adjusted EBITDA to measure the underlying performance of the business, I wanted to touch on this briefly. The largest contributor to the net loss came from the acquisition and termination of a royalty obligation in the third quarter. With the exception of a cash payment of $9.5 million, the consideration paid by Sundial in this transaction was noncash. The transaction eliminated a 10-year cash royalty obligation of 6.5% of gross sales from certain portions of the old facility.

Turning to our cannabis segment. We continue to wrap up our operations, executing extremely well on the build-out and licensing of our growing facilities in Canada, ending the quarter with 74 grow rooms producing cannabis at Olds and another 40 more rooms that are complete and pending licensing in Q4. By the first quarter of 2020, we expect to have 114 rooms completed and licensed at Olds. In the quarter, we harvested about 11,700 kilograms of cannabis, of which 24% was trim, and we sold almost 8,000 kilograms of cannabis. This represents a 70% increase relative to the second quarter. Our ability to ramp up production so quickly over the past few quarters was the result of staying on strategy and focusing on the cultivation of a single strain. This provided several advantages, including optimizing our grow rooms, increasing yields and building on scale in a stable environment. This was a crucial step for us to validate our approach and optimize the growing environment.

As we have built out this capability, we have, as Torsten mentioned, begun to cultivate multiple strains, with the most attractive strains being used for our branded product portfolio. Average selling prices or ASPs were strong in the quarter for both branded flower and unbranded flower at $6.34 and $4.03, respectively. Cannabis net revenue in Q3 was $28 million, with sales to provincial boards representing just over 10% of sales. This ramps up from Q2, where we recognized $19.3 million in net revenue and $2.4 million to provincial boards. We recorded net revenue in Q3 of $2.3 million in branded flower, $17.5 million in unbranded flower and $8.2 million in oil.

The main branded product selling in the boards in retail right now are Lemon Riot, Citrus Punch, Palmetto, Grasslands and Zen Berry. As we ramp up sales of our Sundial, Top Leaf and BC Weed Co. brands, we expect to increase branded product sales entering 2020.

Our gross margin on Sundial-branded cannabis flower sales was 55% and grew from 46% in Q2, with consistent sale prices and reduced cost of goods sold on this product line. As discussed, we will transition to provincial board sales in 2020. We will also transition to our higher-margin premium brands in Cannabis 2.0 products, which will improve margins. Our gross margin on unbranded flower was also strong at 53% for the quarter, stable with Q2, which was 51%.

The company sold winterized oil for the first time in Q3, and the third-party extraction costs related to those sales impacted gross margin on this product.

Turning to operating expenses. G&A as well as sales and marketing costs totaled $14.6 million in the quarter. I mentioned earlier in my remarks the drivers of the increased G&A expense on a consolidated basis. The drivers for G&A in the Canadian segment are consistent with those, say, for the integration cost of the U.K. operations. Our adjusted EBITDA loss in this segment was about $6.3 million in the quarter.

Turning now to our U.K. or ornamental flower segment. The Bridge Farm business is fundamental to our international expansion and is a core part of our strategy to launch and establish global CBD brands. Bridge Farm's current business is producing and marketing edible herbs and ornamental flowers to customers in the U.K. and Europe. Until we transition more space to hemp cultivation and CBD extraction, we plan to retain a portion of Bridge Farm's existing herbs and ornamental flower business.

In the third quarter, revenue from the U.K. business was approximately $5.5 million, and our adjusted EBITDA loss from Bridge Farm this quarter was approximately $1.7 million. To support our Canadian business and global expansion, we've been investing significantly in scaling and optimizing our operations this year. Even during this time of significant investment, we remain disciplined in our capital allocation and have focused our capital spending on the highest return projects. During the quarter, we invested about $27 million in our Canadian cannabis business, almost entirely our flagship Olds facility as we built our production capacity that will support cultivation of multiple strains in our modular purpose-built indoor grow rooms. We are now substantially complete with our Canadian cannabis capital program.

We also invested about $21 million in our U.K. business to continue the second phase of expansion at Bridge Farm, which will support our low-cost CBD at scale and access the renewable heating incentive program that subsidizes energy costs. Our liquidity and capital resources continue to be strong. We recognize that to become a global industry leader, we needed to be well capitalized. As a result, we were prudent in our financings in 2019. We completed our IPO on NASDAQ on August 6, raising approximately USD 143 million of gross proceeds. We secured up to $140 million in corporate credit facilities, consisting of an initial $90 million senior secured term credit facility and the right to an additional facility to a maximum of $50 million. These proceeds, along with second quarter raises, support Sundial to have the required financial capacity to complete our capital expansion in Canada and the U.K. as well as fund its business operations through 2020. Our available cash on hand at the end of the quarter was $142 million.

If we turn to the balance sheet, you will have noted our inventory levels at quarter end were about $28 million. Inventory at the end of the second quarter was approximately $17.5 million on materially lower sales. We are very diligent with our inventory management, and we are laser-focused on balancing sufficient inventory to support our sales growth and new product introductions while minimizing aged inventory. In this past quarter, with our IPO and financing, we significantly strengthened our balance sheet. With the strength of our balance sheet, combined with the expectation of continued growth in 2020, we expect that we will be sufficiently funded to capitalize on the opportunities ahead of us.

As we look forward, we're firmly focused on building sustainable positive adjusted EBITDA into 2020 and over the long term, and we've made much progress. The strength of our management team, our operational capabilities, our agility and flexibility and our CPG approach create a competitive advantage as this industry grows and matures.

For the last several quarters, our clear objective has been on growing our operations to achieve scale; optimize our cultivation practices; build out our brand portfolio; ready ourselves for Cannabis 2.0; and establish our international strategy. We've made the appropriate and prudent investments to support this build-out and secured sufficient capital to do so. While we don't give formal guidance, I wanted to provide some color on guardrails for our business as we enter 2020. We're remaining diligent and focused on cost discipline and will flex our operations to meet the needs of our business.

Our capital expenditure requirements will diminish significantly in 2020 compared to the current year. We expect to broaden our brand portfolio and deepen our brand strength with the end consumer. We will remain agile and flexible as our dynamic industry evolves and be ready to pivot based on consumer trends. The uptake of Cannabis 2.0 form factors, Canadian business expansion and the legalization of cannabis in international markets. In the midterm, we believe we have the right level of funding to support our growth. In short, we strongly believe we're well positioned for profitable expansion of our business.

With that, I'd like to turn it back to Torsten for some concluding remarks.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [5]

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In summary, we are pleased with the continued revenue growth we drove in quarter 3, which puts us near the top of the industry. Our CPG strategy and capabilities as well as the foundations we are laying this year will serve us well as we drive for profitable, sustainable growth in 2020.

With that, we will be happy to take some questions in the time remaining.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from Vivien Azer with Cowen and Company.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [2]

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This is Steve Schneiderman on for Vivien tonight. So just to start off, Jim, you mentioned that there were a number of drivers that would have gotten us back to breakeven adjusted EBITDA number being a onetime item, can you kind of go -- either quantify the impacts of each of those or at least put them in the order of magnitude of which ones were the biggest drivers? And if we think about also what led to just operating capabilities and profitability, whether it was the wholesaling, scaling up the organization, public company expense or acquisition costs, what are -- is driving some of the profitability [we see there]?

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James Keough, Sundial Growers Inc. - CFO [3]

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Sure, Steve. I think what I was trying to do here is to provide you with some perspective. I mean clearly, the published adjusted EBITDA number we have is minus $7.9 million. But I wanted to just point out that there is a number of costs that occurred during that period that are not usual. And to provide some perspective on what a usual normalized adjusted EBITDA number will be for us going forward. So certainly, as we enter the realm of becoming a public company and scaling up our business and implementing information systems, et cetera, there was a lot of consulting costs that were involved. And of the $8 million add back to get back to breakeven, that's probably about 50% of those costs. We also had the integration of the U.K. business and the U.K. EBITDA results. And that accounts for about 50% of those -- sorry, about 25% of those, excuse me. And then, in addition, there was a number of onetime items that we saw either related to the IPO or to other kinds of transactions during the quarter that relate to about another 25%. So adding all those back together, we would approach, on a normalized basis, something around breakeven. And clearly, though, the adjusted EBITDA published number was the $7.9 million.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [4]

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Okay. Great. That's helpful. And thinking about your revenue mix, I guess, particularly, as we think about the sales of the provincials, can you help us unpack this one a little bit? So you mentioned doing $2.4 million in Q2 to the boards, that's going into Alberta with 2 SKUs. You finished the quarter in 6 provinces, I believe, 6 SKUs a piece with Zen Berry, Lemon Ride, and Citrus Punch, yet it's only about 20% increase quarter-over-quarter. Can you talk about what drove performance and how we should think about that over the next couple of quarters?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [5]

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Yes, let me take a stab at this here, and maybe the rest of the team will jump in. So obviously, we just launched sequentially across the provincial boards here in the third quarter and not all our SKUs everywhere. And there's, of course, initial load-in as well, so the AGLC sales that we had in quarter 2 were pretty significant because at that time, remember, was also significant supply constraints still in place. So you heard us say that we think we'll be towards half of our sales by the end of the first half of next year. We'll be through provincial boards, and that will gradually build. So as we get more of the strains growing as we get the new formats and as we get all of those SKUs to all of those provinces and hopefully, additional ones, that's really what's going to drive the sequential contribution increase of the branded sales versus the wholesale.

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Steven Jason Schneiderman, Cowen and Company, LLC, Research Division - Research Associate [6]

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Okay. Great. And finally for me, on the U.K., can you talk about some of the regulatory and the wholesale progress that has been made over there in terms of what licenses are you waiting on, your expected timing? And where you are in terms of sourcing CBD input from third parties?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [7]

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Sure. Actually, Louise, our newly promoted MD for the U.K. is on -- Louise, you want to just talk a little bit about where we are in terms of preparations for CBD and the licensing process?

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Louise Motala, Sundial Growers Inc. - MD of Sundial UK [8]

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Sure. And if I take licensing first, we are continuing to work with the Home Office, and we're working with them very closely on the multistep licensing process and starting with the R&D license. We have a Home Office visit on the 25th of November, and we're expecting to get that license over the line by the end of Q4, and then we will progress to apply for the license at Clay Lake early in 2020. And then in terms of, I guess, customer conversations going well, with CBD of high demand in the U.K., as you probably well know and we are -- and those conversations with key retailers are progressing exceptionally well. And in the meantime, while we wait for our own cultivations come on stream, we are pursuing a potential product launches and potential product introductions using imported CBD oils from trusted source from Europe.

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Operator [9]

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Our next question comes from Doug Miehm with RBC Capital Markets.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [10]

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I guess the first question, I just want to spend a little bit of time on the costs associated with the winterized oil. How many grams of product were sent to facilitate the production of the -- what you ultimately sold, the $8.2 million?

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James Keough, Sundial Growers Inc. - CFO [11]

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Yes, Doug, the number of grams of bulk flower that went into extraction was about 3.1 million grams.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [12]

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Okay. And so it's fair to say that you were basically selling that at below your cost to produce it, correct?

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James Keough, Sundial Growers Inc. - CFO [13]

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Yes, we sent this to third parties for extraction, and so there was additional costs associated with the extraction, and those costs are higher than what they'll be as we bring our own processing facilities online. But this was really an initiative that we undertook to manage inventory, and so yes, we accepted a lower margin on that, but it was essentially a breakeven proposition.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [14]

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Okay. The $2.3 million, just so I understood you right -- correctly -- or correctly, Torsten, were Alberta sales down in Q3 versus Q2? Or was that not the case?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [15]

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Yes, I think that you got to look at sell-in and sell-out so what sells through. And so the initial inventory built was obviously significant. So the sell-through numbers, we're still looking through the data, but I think the sell-through is increasing. It's just the inventory levels, as you probably know, in general, of the provincial boards have come down a little bit as they have more SKUs. So the sell-through is positive. The sell-in in Alberta, specifically, in the third quarter was down a bit.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [16]

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Okay. Perfect. Maybe you can speak to then the yield per square foot that you're seeing in the facility as you've understood it, and you have the new strains coming through and that sort of thing. Are you seeing that staying at the high level that you had before?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [17]

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I'll have Andrew answer that one.

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Andrew Stordeur, Sundial Growers Inc. - President of Canada [18]

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Doug, it's Andrew here, President in Canada. Yes, so in regards to the new strains, obviously, we kind of scaled up with the one strain throughout kind of the first part of the year. We've got about 20 of the new strains, as Torsten mentioned, that we're actually executing now in the facility. We're seeing pretty consistent yields as those new strains kind of commission in the rooms. Some of them are coming down slightly, but we're still definitely on target as far as what we expect. And we're testing and learning a little bit as they go. So absolutely on kind of plan for what we expect. And in some case, better yields on some of the new strains that we brought in. So relatively speaking, well in the zone of what we expected.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [19]

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Yes, Doug, let me just add to what Andrew just said because I think just as important as we go forward here as an industry, it's not just going to be yields, right? It's really going to be the quality of the product that's coming on. And that is partially the visible quality, but it's also the active ingredient percentages. And I think the market is actually quickly and more quickly than we even anticipated moving where we are, which is we think that we have a large portion of the premium indoor production capacity that can grow the most difficult strains at highest active ingredient and consistently high quality. I mean therefore, you'll hear us talk much more about a balanced view, not just about yield but also about active ingredients as well as kind of quality and the revenue-generating potential that provides us in the recreational market.

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Douglas Miehm, RBC Capital Markets, Research Division - Analyst [20]

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Okay. That's great. And then just last question. [Of] the $28 million in inventory, you're going to have to send any of that to -- for extraction as well? Or was most of that available for sale?

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Andrew Stordeur, Sundial Growers Inc. - President of Canada [21]

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Yes, we've got to -- Doug, it's Andrew here. The combination of that is set up for what we got [planning] to go out for some of our provincial board sales. Some of that's obviously going into the wholesale market. And as we navigate some of the strains that we want to put into our Phase 2 product, some of that's going to go for extraction. So it's a combination of kind of all variables there.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [22]

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Plus new formats. And so a combination of all those.

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Operator [23]

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Our next question is from Tamy Chen with BMO Capital Markets.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [24]

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First question is just surprised by the amounts that you sold into the LP-to-LP market. Seeing that a number of these other LPs are becoming themselves, net sellers in this channel. So I'm just wondering, where is this demand coming from? I mean who, in general, are you selling it to? And what you experienced this quarter? How should we think about that going forward? Is this sort of level potentially sustainable or not?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [25]

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Yes. Thanks, Tamy. Look, I think what you're beginning to see here that -- is that cannabis is equal to other cannabis, right? And the reason why we are continuing to sell really well to other LPs is because the quality that we can consistently deliver, many of the facilities in the country are simply not equipped for. And as some of the LPs have either reduced their own growing and/or require a certain product at quality levels or quantities or consistencies that they have committed to boards and can't meet, they are looking for the few people that can grow at scale consistently at high quality. And as you know, we're very proud of the facilities that we run and our people that drive that cultivation, and that's why we are -- continued to be bullish on having superior product that's not going to only enable more branded sales but also going to have a different price elasticity in the wholesale market than other producers.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [26]

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Okay. And could you talk a little bit more about this inventory management that you did in the quarter? What was that about? And this winterized oil sale, why did you devolve about the 3,000 kilograms to be extracted into oils to sell to? I'm guessing it's to other LPs.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [27]

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Yes, look, it vary pragmatically. We grew a little bit too much Shishkaberry. So we had all of our rooms are -- practically all of our rooms growing that strain. And as you know, demand was very high, wholesale and retail. And that pivoted a little bit, and there was more diversity required of the strains, we had a lot of Shishkaberry inventory. And with our inventory room and our operational facilities requiring the flexibility to quickly grow the new strains and process those, it made sense for us to just adjust the Shishkaberry inventory to levels that are kind of organic and sustainable. And therefore, we decided to sell some of it as unbranded flower but also decided to convert some of it. And Andrew, I think, is going to add a point as well.

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Andrew Stordeur, Sundial Growers Inc. - President of Canada [28]

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Yes, just the message on that. I think it's important to note that, obviously, the number of grams that we had extracted was a combination of flower and trim. So I mean that's -- it's a slightly different kind of view on it. We just got to be mindful of that as we kind of look at the decision we made there. And it's important to note, not all flowers so some of that trim, and that's how we do trim. We extract it. So important to note there.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [29]

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Yes, good point.

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Tamy Chen, BMO Capital Markets Equity Research - Analyst [30]

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Got it. Okay. My last question is on this guidance of pivoting or transitioning more to rec and less so in the LP-LP market going forward, I guess kind of a 2-part question here, but you touched on that you're growing more strains now. So is it that some of the current strains, I guess, the Shishkaberry that you've been growing primarily of, is there -- are you not seeing as much demand even at the province level for this particular strain? And then the second part of the question is as we think about your ability to pivot more into rec, can you touch a bit on or provide an update on your packaging capabilities at this point?

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Ryan Hellard, Sundial Growers Inc. - Chief Experience Officer [31]

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It's Ryan Hellard, the Chief Experience Officer. So when you look at Shishkaberry as a whole, demand, I would say, across the board is dropping regardless LP, provincial boards. Really, it was a strain that was widely available by virtually every company because it was one of these strains that was initially available under the ACMPR, and therefore, it was widely distributed. And basically, the boards have more than enough of it to last them. And so at this point, really, the demand for it is very low. And I think that's passing through to the consumers is that as the number of strains grew, demand for different genetics just became higher. And that was always our view of what would happen in the market. And that's why we took the initiative early in Q3 to really start developing a larger portfolio of SKUs that we could go to the market with. And sorry, your second question was?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [32]

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Packaging side.

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Ryan Hellard, Sundial Growers Inc. - Chief Experience Officer [33]

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And from a -- sorry, from a packaging perspective, we've -- during quarter 3, we brought onboard our first automated packaging line, which really increased our capabilities there. And we are right now bringing onboard our second packaging line, which once again will significantly increase our ability to bottle. So in line with our other cultivation strategies, we brought on the processing power to not only cultivate new strains but also to bring those new strains to market.

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Operator [34]

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Our next question comes from John Zamparo with CIBC.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [35]

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I also wanted to follow-up on the winterized oil piece. Can you just clarify for us what the gross margin on this was? You listed it for the other 3 products.

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James Keough, Sundial Growers Inc. - CFO [36]

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Yes, John, it's Jim. It was very slightly negative. Under 10% negative margin. So essentially, a breakeven. And that includes the cost of the bulk cannabis and the third-party extraction, which added relatively significant cost to it. So the combination of those comes down to that gross margin level.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [37]

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And important to point out that in the future as we in-source extraction, obviously, that creates more margin flexibility. And again, this is not something that we're planning to do on an ongoing basis, this was a onetime adjustment to inventory.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [38]

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Okay. Understood. So just help me understand, on the inventory management, if it's at a negative margin, is there a reason you needed to ship it or produce the oil entirely? Was it like a commitment to a province or to a customer?

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James Keough, Sundial Growers Inc. - CFO [39]

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Yes. No, it wasn't a particular commitment. I mean it was really, we wanted to take decisive action. I mean we don't want to have aged inventory on hand. And so we wanted to take decisive action, and this was a mechanism that we were able to do that. The cost, as Torsten said, is much higher with the third-party extraction cost, and this was a onetime initiative. As we move forward, if this initiative we undertake with our own processing, that margin will be -- will look significantly different, and it's only one tool that we have to manage inventory, but it is one that we exercised during this quarter.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [40]

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Yes, and look, margin allocation is also quite challenging, right? Because you can look at trim in 2 ways. You can look at trim and allocate costs to it or not and just look at it as free, right? If you take trim as free, and you need to move your trim, then you could say this was profitable. So it's really a blended approach that we took. We looked at all of the inventory that we had in trim and flower and the aging of some of that inventory and what the alternative uses of that was going to be. As we project the demand, it just felt that, that was the most prudent use of that product.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [41]

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Okay. Understood. That's helpful. Maybe talking about market share, so some of the larger provinces and the ones that you've been -- I know it's not all that long, but for some length of time, how are you seeing market share develop on a month-over-month basis?

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Ryan Hellard, Sundial Growers Inc. - Chief Experience Officer [42]

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It's Ryan, again. We're seeing good trends in market share in the -- moving in the right direction. A lot of the new genetics that we launched and new SKUs that we launched are heavily contributing to that. As was alluded to earlier, the Lemon Ride has been a really strong seller for us. And so each one of the new products that we've released has seen much stronger velocity than our original Zen Berry, so we're moving in the right direction from a market share and from just a national footprint as we moved into a significantly larger number of provinces in Q3.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [43]

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Okay. Great. And then last one from me is on the U.K. I appreciate the commentary on the R&D license, but when do you anticipate at this point, you'll have CBD sales from outside providers? And then when do you expect to be able to cultivate CBD at this point?

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [44]

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I expect both of those next year. And I know that's a huge window, right, and we had before been kind of conservative in pushing that potential beyond 2020. But the way that the commercial conversations are going and the way that the licensing is progressing and the conversations about how we alternatively can bring products to market, we're confident that, that's going to be the case. Within that, it will be -- it won't be December, so I think the middle of the year is probably a fair point at this point to raise in terms of being able to begin commercialization of CBD products in the U.K.

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Operator [45]

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This concludes the time allocated for question-and-answer session. I would like to turn the conference back over to Torsten Kuenzlen for any closing remarks.

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Torsten Kuenzlen, Sundial Growers Inc. - CEO & Director [46]

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No, just thank everybody here for attending, listening in. Appreciate your support and happy to answer any more questions that you might have, if you reach out to our Investor Relations department here, Jayson Moss or any of us, we'd be happy to answer additional questions. And then look forward to keeping you abreast and formally speaking with you in March when we'll be announcing the full year 2019 and quarter 4 results of Sundial.

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Operator [47]

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