Good morning and welcome to Sundial Growers' First Quarter 2021 Financial Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions.

[Operator instructions] Yesterday afternoon, Sundial issued a press release announcing their financial results for the first quarter ended March 31, 2021. This press release is available on the company's website at sndlgroup.com and filed on EDGAR and SEDAR as well.

Presenting on this morning's call we have Zach George, Chief Executive Officer; Jim Keough, Chief Financial Officer; and Andrew Stordeur, President and Chief Operating 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. I'd also like to note that we are conducting the call today from our respective remote locations.

As such, there may be brief delays, crosstalk or minor technical issues during this call. We thank you in advance for your patience and understanding. We will now make prepared remarks and then we'll move on to the question-and-answer session. I would now like to turn the call over to Zach George..

Good morning, everyone and thank you for joining us on our first quarter 2021 earnings call. We are now more than a year into this global pandemic. Unfortunately, COVID-19 continues to significantly affect Canadians as the third wave is in full force.

That said, we believe that there's light at the end of the tunnel as vaccines are currently proliferating across the country and the world. Our top priority remains the health and safety of our employees. We remain committed to stringent procedures to ensure the protection of our employees and consumers, while minimizing disruption to our operations.

Despite the negative impact the store closures and orders to stay-at-home have had on retail sales, we are grateful to be designated as an essential service provider, which has enabled us to continue to operate and serve customers and consumers while so many small and medium-sized businesses have not had the same opportunity.

We are pleased to announce Sundial's first-ever quarter with positive results from adjusted EBITDA.

This result reflects the continued efforts from our teams across the organization to build a platform targeting attractive capital deployment opportunities, while we focus on the continued improvement of our cultivation practices in an immature and rapidly changing industry.

Sundial continues to focus on operational improvements and capital deployment opportunities both of which will enable Sundial to become a stronger and more diverse cannabis company. Since December we have made a number of investments across the capital structure of public cannabis companies.

And last week we entered into an agreement to acquire all of the issued and outstanding common shares of Inner Spirit Holdings and the Spiritleaf retail cannabis network. We are pleased with our investment track record which started with our internal program and has evolved to include a partnership with third-party capital.

While we have made several significant strategic investments this past quarter, we continue to see a robust pipeline of additional investment and M&A opportunities. Sundial remains debt-free and has a total capital base including liquid securities, loan assets and an unrestricted cash balance of more than CAD 1 billion.

Today approximately 70% of this balance sits in unrestricted cash. Maximizing our returns on deployed capital and corporate stewardship are key priorities for our board and management team. At the end of the first quarter of 2021, the company had deployed approximately CAD 96 million into several cannabis-related investments.

These investments generated CAD 15.7 million in interest income and fees including 12.9 million of realized and unrealized gains on marketable securities. As of today's call, we see absolute realized and unrealized gains in Q2 that are greater than that of Q1.

However, much of this exposure is subject to market risk and may change prior to the end of the second quarter. In terms of our cannabis operations, Sundial remains focused and committed to its cultivation and processing activities and the improvement of its cultivation outcomes.

Revenue declines in the first quarter were the results of the continued growth of the discount segment, inventory monetization across Sundial's Grassland brand and slower industry sales driven by seasonality and COVID-19 restrictions across Canada.

Our negative gross margin in Q1 was largely attributable to aggressive price reductions on our Grasslands products undertaken to optimize inventory levels to align with demand in addition to maintenance capital items and an unanticipated spike in utility pricing in February.

Moving forward, we will be limiting the offering of discount products in markets where we view the economics as neither attractive nor sustainable. Sundial has no interest in pursuing unprofitable revenue growth and we are unwilling to seek the maintenance of market share at all costs.

We believe that the combination of continued oversupply, a lack of differentiation in the majority of branded product in addition to regulatory and operating dysfunction at many levels will create a reckoning for the industry during 2021.

We welcome this reckoning as the rationalization and regulatory evolution moves the Canadian recreational industry toward greater health over the next several years.

We have made progress with our cultivation results and Andrew will provide more details, but we still have work to do in our core operations to achieve the goals that we have established for Sundial and our shareholders.

We continue to see some of our Canadian peers move away from cultivation partially or entirely, due to the inability to deliver consistent cultivation outcomes. But we have not wavered with our commitment to cultivation in our indoor modular facility and our brand promise to consumers is fundamental to our strategy.

We continue to maintain our focus on keeping our employees safe and adjusting to market demands. Our strong financial position, unique cultivation facility and focus on premium inhalables have positioned us for improved performance in the second half of 2021 and beyond. I am excited about Sundial's future and our competitive positioning. Thank you all.

I will now pass it to Jim for commentary on our financial results..

Thanks, Zach and good morning to all who are listening in. I would like to remind everyone that all amounts that I mentioned this morning are denominated in Canadian dollars, unless otherwise stated. Let's start with a review of the improvements that we've achieved in our liquidity and capital structure during the quarter.

We opened 2021 with CAD60 million of cash on hand. By the end of Q1, that number was CAD873 million. And as of May 7, 2021, the company had an unrestricted cash balance of approximately CAD753 million, in addition to investments in marketable securities at market value of CAD327 million for a total of CAD1.08 billion when combined.

Our outstanding share count was CAD1.77 billion at the end of Q1 and sits at CAD1.86 billion today. During the first quarter of 2021 Sundial issued 857 million common shares pursuant to at-the-market equity programs, registered direct offerings and warrant exercises for total proceeds of CAD854 million.

Subsequent to the quarter-end, the company issued 85 million shares through its at-the-market equity program for total proceeds of CAD97.7 million. The first quarter of 2021 was a transitional period for Sundial and we have realigned our business into two segments for operational and reporting purposes.

One being cannabis operations and the other being investments. By the end of the first quarter of 2021, the company had deployed a portion of the capital raised into several cannabis-related investments, totaling CAD96 million.

During Q1, the company realized CAD2.8 million of interest in fee revenue from loans to third parties and CAD12.9 million in realized and unrealized gains from investments in marketable securities.

This revenue is being classified as income from operations, reflecting the new segmentation of our operations and we intend to continue to deploy significant capital, targeting a portfolio of enhanced risk-return opportunities in the cannabis industry to provide exposure to attractive debt equity and hybrid instruments.

Now, let me explain the net loss for the quarter in more detail. Net loss for the three months ended March 31, 2021 was CAD134.4 million, compared to a net loss of CAD64.1 million in the previous quarter.

Effectively, all of this net loss arose from CAD130 million of non-cash fair value adjustments that are required under IFRS reporting on the derivative warrants attached to the direct offerings that were issued during the quarter. There was no cash impact from the fair value changes resulting from these valuation adjustments.

There will be no cash payment ever for the derivative warrants amount that is disclosed on our balance sheet. These two amounts will fluctuate each quarter with our share price until the warrants are exercised or expired.

For clarity, management estimates that if this revaluation was done using market conditions as of May 10, 2021, the fair value of the outstanding derivative warrants, which are shown as a liability on our balance sheet would decrease by approximately CAD34 million. There would be a non-cash gain on our income statement of the same amount.

Sundial continued to strategically deploy its capital throughout the first quarter and subsequent to quarter-end. To summarize our deployment of capital in our investment segment to date, Sundial invested CAD22 million in Indiva Ltd., a Canadian producer of cannabis edibles.

We entered into a strategic capital partnership with the SAF Group, focused on cannabis-related opportunities and investments in Canada and internationally. The first mandate of the joint venture is a special opportunity fund with an initial commitment of CAD188 million by Sundial, in addition to commitments from third-party limited partners.

Sundial acquired just over 10% of the issued and outstanding common shares of the Valens Company Inc. Valens is a research-driven, vertically integrated, end-to-end developer and manufacturer of innovative cannabinoid-based products.

Sundial also announced that it entered into an arrangement agreement, pursuant to which the company will acquire all of the issued and outstanding common shares of Inner Spirit Holdings and the Spiritleaf retail cannabis network for total consideration of approximately CAD131 million, including cash of approximately CAD102 million.

Now let's turn our focus to the operating results, starting with adjusted EBITDA. Sundial recorded its first-ever adjusted EBITDA of CAD3.3 million in Q1 2021, compared to an adjusted EBITDA loss of CAD 5.6 million in the prior quarter.

The significant increase was mainly due to realized investment gains and income from the company's strategic cannabis-related portfolio investments. As discussed, this will be a core part of Sundial's operations moving forward.

In Q1, we've seen cash flow improvements due to investment revenue as well as realignment and refinement of our cannabis operating model. In the first quarter, cash provided from operations was positive CAD 2.3 million before changes in working capital, including the first quarter of investment revenue.

In the previous quarter, the company used CAD 12.2 million from operations. Net revenue from cannabis for the first quarter declined by 29% to CAD 9.9 million from CAD 13.9 million in the previous quarter.

Sales were negatively impacted by provincial boards reducing inventory levels, retail market conditions and continued price compression across the industry in Sundial's product portfolio.

Average gross selling price per gram equivalent of branded products net of provisions was CAD 3.15 per gram compared to CAD 4.14 per gram in the prior quarter, reflecting the industry price compression and a consumer shift to value products.

General and administrative expenses were about 9% higher at CAD 7.1 million, compared to CAD 6.5 million for the previous quarter, reflecting legal and other fees related to the investment segment and the build-out of our direct sales team.

In Q1 2021, sales and marketing expenses reflect spending discipline and seasonality at CAD 950,000 compared to CAD 2.3 million in the previous quarter. We have increased investment commitments in both our sales and marketing teams and have added key additional team members.

Adjusted gross margin before inventory impairment and fair value adjustments was negative CAD 1.6 million, compared to CAD 3.2 million for the previous quarter.

This was despite our improvements from cost optimization initiatives, our focus on margin accretive strains and SKUs and improved cultivation outcomes due primarily to market price trends and to value priced products. There is more work to be done to improve our margins for cannabis operations.

Total capital expenditures in the first quarter of 2021 were not material, but we have budgeted CAD 5.7 million in capital expenditures for full year 2021 related to processing automation, minor facility improvements and maintenance capital.

Now I would like to invite Andrew Stordeur, President and COO of Sundial to provide remarks related to cannabis operations..

people, process and plants. Now let me start with people. In quarter one, we restructured our supply and operations teams at our Olds facility. We believe that a more streamlined organization will allow our teams to become more nimble and make more informed decisions given the dynamic nature of the industry.

We have recently invested in cultivation leadership and we'll also be adding product engineer capability at our Olds facility to develop a more sustainable innovations launch program. We went from more than 100 SKUs at the beginning of 2020 to less than 40 SKUs at the beginning of this year.

We launched three concentrate SKUs in the first quarter of 2021 under the Top Leaf and Grasslands brands. We signed a new partnership with Stigma Grow to develop additional hydrocarbon concentrate offerings under our Top Leaf brand.

Our innovation pipeline for the balance of 2021 is focused and we'll be launching several new products in the next few months. Our second cultivation pillar is around process. With over 700 harvests since inception, Sundial has tremendous access to cultivation data and insights.

Our team is currently in the process of revamping our entire genetics playbook, which will allow us to drive further cultivation consistency. In quarter one, Sundial harvested its highest potency flower since the Olds facility's inception with Top Leaf's LA Kush Cake initial lots producing potency in excess of 28% THC.

The product has seen strong velocity since launch. We have increased our average potency results by approximately 15% year-over-year. And finally, our third cultivation pillar is around plants.

We continue to invest in developing a library of cultivars that look to achieve a combination of higher potency, more robust terpene profiles and above-average yield. We received our first laboratory results and our new extended library of genetics, and we'll prioritize these for launch in the fourth quarter of 2021. Our focus is still on brand sales.

However, we have seen an increasing sales trend in wholesale market opportunities. We feel that Sundial is well positioned to take advantage of these B2B opportunities as other licensed producers divest from cultivation practices. These pillars are underpinned by our continuous focus on reducing costs.

In the first quarter of 2021, our cultivation and production costs were reduced to an average of $4 million per month from $10 million per month in the first quarter of 2020. Our top-line numbers regressed versus Q4, 2020 and year over year.

As Zach mentioned earlier, Sundial will not pursue unprofitable revenue growth and we are unwilling to grow market share at all costs.

We believe, increasing our investment into our direct sales team will enable us to win by accelerating the distribution of our products through new customer acquisition, brand activation and by improving education with both customers and consumers on our product portfolio.

As a result, we added 13 dedicated salespeople to the organization in Quarter 1 which significantly improves the breadth and frequency of our customer coverage and will be a key enabler to increasing our market share in the core and premium segments moving forward.

With an increased focus on driving the right assortment at store level, our new retail team increased distribution on Sundial's priority SKUs by 25% across several key markets in the first quarter.

While we are encouraged with the progress made in operations for Quarter 1, we still have work to do on driving a sustainably profitable cannabis operation segment with cultivation excellence at our core. With that I'd like to turn the call back to Zach for closing remarks..

I thank our team for their efforts our customers for their trust and our shareholders for their continued support as we work to position Sundial for success. Thank you for joining us today and please stay safe. I will now turn it back over to the operator for the question period..

Thank you. [Operator instructions] Our first question comes from Tamy Chen of BMO Capital Markets. Please go ahead. .

Thanks. Good morning everyone.

First, I wanted to ask, if you could explain a bit more on the rationale for the acquisition of the Inner Spirit, you know franchise and some corporate stores? Is it to you know have your marketing team better engage with this network of stores to increase penetration of Sundial products? Just if you could elaborate a bit more on the thinking of why acquiring into retail..

Hi Tamy. Good morning. Thanks for the question. Unfortunately, we're going to actually punt on this question for now. We are satisfying a number of conditions to close the transaction and we'll be providing a very fulsome update closer to the time of close which as we said is early in Q3.

And we'd be happy to give a much more detailed answer at that time. .

Okay. Fair enough. Then if we can pivot to what's been happening in the rec market here. So, noticing you know in the press release and then in comments you're talking about this sort of sustained price decline in flower in Canada.

So, I wanted to ask you know first off, why in your view this is sustaining? How long do you think it might continue? And how do you think about this overarching dynamic as you're trying to drive more higher-margin sales which would naturally come with higher price point products? Thanks..

Hey Tamy, it's Andrew here. Thanks for the question. Yeah, I think first and foremost the price compression continues and I think we've seen that you know as of last year moving into this year as well. So as far as timelines go on that we're going to be in that position I think as an industry for a while.

And I think largely that's driven by high inventory levels and really monetizing that inventory across all provinces with a lot of licensed producers. So it's here to stay for a while.

But as you mentioned you know we're pretty optimistic given that this is a consumer product category that we're going to see you know the core and premium segments move in the right direction. That's going to take a little bit of time.

And I think you know the important thing for our position on that is, you know we have the ability to, not chase revenue and not chase market share in the discount segment. Our balance sheet is extremely strong. And you know we have the ability to lead for a healthy industry dynamic.

And I think we stated in the opening comments you know one of the key actions we're taking is really get selective on key markets and when to make decisions on pulling out of some markets on the discount segment. And I think that's a good thing for the industry and that's certainly a good thing for Sundial.

And you know we're going to continue to focus on. We mentioned the frontline sales investment that we have. I can tell you whole-heartedly that that team's not going to be focused on driving discount products and really renting market share. They're going to be talking about our premium offerings Top Leaf and certainly at Sundial.

And you know I think consumers want to hear that. Certainly, our customers want to hear that. And that's really where we're focused on. So we're in this for a little bit a while longer no question but we're pretty optimistic that you know the segment is going to move consistent with other more established categories in CPG. .

Got it. Thank you..

Our next question comes from David Kideckel of ATB Capital Markets. Please go ahead..

Hi. Good morning. Congratulations on the quarter. Thanks for taking my questions. I want to go back a little bit to your strategy here Zach and team with acquisitions [taking a stake] (ph) in companies now.

Not to mention the Inner Spirit Holdings acquisition specifically, but can you maybe help us understand -- I mean what is the overarching strategy here? We note that you know you are in the process of acquiring Inner Spirit versus you know taking a stake in other companies. I think you mentioned on the -- on your prepared remarks balanced company.

There's also Indiva. So what is the overarching strategy here? Is it a combination of both, or are there certain metrics you're looking for in certain companies to decide how to proceed, or just any commentary on the strategy there, would be helpful. Thanks..

Sure. Good morning David and thanks for the question. So look, I think the strategy on capital deployment is very much in line with our commentary from last quarter. So we do see in Canada consolidation on its way in a material manner and we are looking at opportunities in this space from really two main perspectives.

One in terms of classic M&A, where we can consolidate or be a consolidator take a certain cost out of a structure and position ourselves well in the Canadian market.

And then we also have the ability through our partnerships and what we've done off of our own balance sheet to look at asymmetric investment opportunities, which are really just that, where we see an attractive risk-reward. And typically, the opportunity to earn modest equity-like returns in many cases higher up in the capital structure.

So when you look at some of the small stakes we've taken in the equity of certain businesses, the common theme that you see is really a differentiated model from our perspective that would not apply to certainly every company or business model in Canada.

But from our perspectives there are a few that really stand out in terms of capabilities and what we perceive as a strong future role in the Canadian landscape. So we think that will evolve over time, you'll likely see us recycle capital in a number of instances. There are many reasons why you know smart M&A transactions never get completed.

But we are -- we continue to have wide-ranging discussions with a number of parties in the industry and are trying to walk slowly toward these transactions that we think make a lot of sense for Sundial shareholders..

Understood. Thanks for that color. And I would agree with you Zach. For one you know this is very differentiated in what looks like a potentially lucrative business model.

So with that said I think Jim or Andrew you mentioned, two of your operating models share both the reporting and strategic purposes include both the cannabis is number one and number two is your investment model.

Shifting back to your cannabis business right here, I think Zach as well you mentioned you know you have the potential to stop unprofitable business segments within your cannabis segment.

So I'm just wondering from the potential that you have now with your balance sheet with over a billion dollars and the investments you're making into companies why bother with cannabis? And so far as you know we're seeing where the market is and all the challenges there when in fact your investment side of the business could potentially be much more lucrative than cannabis.

So in other words is all this trouble worth the effort? Thanks..

Let me just answer and then I'll pass it to Andrew. But I think what we're seeing is as we mentioned a number of and as you know as well David, a number of our peers are effectively moving away from cultivation. We have what we believe is a world-class facility.

As we've really learned to operate within that facility and refine our cultivation practices we've reached improved results. We do see this as a commodity business at the end of the day. And so I think it's a contrarian perspective to take to effectively triple down on cultivation, but one that we're embracing.

And I think that you're going to see more cultivation get pulled out of the system, you're going to see a wholesale market that comes back in a very robust manner as this industry evolves. And you've got some -- a small number of very strong players that have very, very low-cost structures.

What we're trying to attack is really the premium flower segment and it all comes down to really usable plant matter and cultivation outcomes. We need to have narrower, more consistent outcomes and that's really the charge that Andrew's been leading..

David, I'll just add to that. Look, I think you know we were pretty mainly focused on inhalable and that's obviously the largest segment inside of cannabis. Our right to win in that is really predicated on cultivation. Now, as Zach mentioned, we have this small-budget scale facility that really will enable that strategy to really take hold.

And look there are some small micro growers out there and they're doing a fabulous job but nobody's done it at scale. And that's really our mandate, right? If we do that really, really well and this side of the business is all about making it as boring as possible and as predictive, as Zach mentioned, as possible.

So when we do that and when we're able to actually drive that cultivation consistency at a scale that really nobody is doing in the industry globally, quite frankly, that's really our right to win and that's what we focus on. When we do that, it's going to have a significant impact on our ability to kind of drive our shareholders' value..

Okay. That's very helpful. Thank you. And then if I can just squeeze one quick one related to both, what you guys were talking about here. Just with respect to your JV with the SAF Group and your previous commentary on the potential stack.

Is there opportunities then to build from within to potentially spin one of your own internal businesses out here and into a stack, or should we be thinking about these as more external opportunities? Thanks and I'm going to hop back into the queue..

Sure, David. So, yes, you should be thinking about those vehicles today as oriented to pursue external opportunities.

Your point on spinning out segments could be a very important discussion two or three years out, to the extent that we have more scale and a stabilized business that we think as a pure play would have a better positioning in the markets in North America. We're certainly not there yet.

We're just at the early stages of the development of this platform, but it's surely something that we're thinking about as we look further down the road. Given the constraints of the stack structure, you're likely not going to see the stack look at any of our internal assets as a qualifying transaction.

And we expect to provide the market with an update on our partnership with SAF, the third-party funds that we're engaged in raising today, as well as any updates related to the stack in the next 30 to 60 days..

Okay. Thanks very much and congrats on the quarter..

Our next question comes from Pablo Zuanic of Cantor Fitzgerald. Please go ahead..

Thank you and good morning. Two questions. One, regarding M&A, as you describe it.

Can you talk about opportunities, if you're thinking of opportunities overseas or, say, in the US? And related to that, I'm assuming that because of your US listings -- soluble US listing, you are more limited in terms of doing businesses or acquiring businesses in the US. And the second question is more on the operational side.

I understand, you're going through a transition period you have a war chest there with all that cash that was raised, but you have reported sales to the provincial board, say, about 37% sequentially. Can you give some context around that number? What were the retail underlying trends? I suppose you were better than minus 37.

And then, just elaborate, in terms of, what you need to do better to improve that number, right? What I'm learning and maybe I'm wrong, is that small companies can do very well in the value end or the lower price points, other companies can do very well in the high premium, but the scale doesn't necessarily seem to be a recipe for success necessarily, right? So just talk about how you can improve the business, relative to what was up, the job that you reported in the first quarter.

Thank you..

Sure. Let me let Andrew speak to revenue and the current market environment and steps we're taking to improve core operations. But on the first question, regarding M&A, Pablo, you're correct to point out that our NASDAQ listing creates challenges for us to directly invest in plan touching assets in the US.

We think that opportunity set will evolve over time and there’s various ways that we can take advantage of opportunities in the US, as some of our peers have in a structured manner or through entering for distribution or product mix that is not THC-related, but that's an evolving scenario.

We are getting presented with a lot of opportunities internationally. We have vehicles, we have the capital to look at and take advantage of those opportunities.

But I will say that we are very committed and focused on being successful in Canada and being a part of what we think will be a very healthy landscape when we emerge from the current dysfunction in the next two to three years..

Hey, Pablo, it's Andrew here. Thanks for the question. I'll break this up into two pieces, because I think there was this concept around kind of what's happening in the industry and some of the dynamics there that we're dealing with in Canada and then what are we doing about it specific to the operations.

Let me give you some color on kind of what's happening, certainly, what we saw in Q1 and we're seeing the same thing kind of in Q2 with regards to industry headwinds. So first and foremost, look, the industry was down in January and February. We saw a bounce back in March, but we had a slow industry to start with.

I think, don't want to belabor the point around pricing dynamics, but that's real and the discount segment. I mean we used to have value, but now we've got value and discount and the discount segment is accelerating at an unsustainable pace and it's certainly not an area that Sundial wants to lead on.

Nothing [Indiscernible] We saw some provincial boards do what they needed to do with regards to managing their inventory and reducing weeks of coverage. And that's really impacted us in the first quarter, largely in Western Canada. That said, moving forward, you know as I stated before, our strategy is still very much in the inhalables piece.

And we need to drive a better product mix, particularly in a brand like Top Leaf. And we have some outstanding strong pricing on Top Leaf. We're close to $7 a gram, in the markets that we compete in that premium segment and that's significant. And as we drive a better premium segments, mix into our profile. That's what we want to see.

And that's going to mean, we're going to have to make some tough decisions, but the right decision, when it comes to walking away from the discount segment like, markets or it's just doesn't make sense. Let me just quickly touch on the upside.

I'd love to say that, the progress in the operation side and the facility, follows kind of a 90-day window, in a fiscal calendar, but it's not that simple. We've been in operations really for about 2.5 years here. And we've been focused really on optimizing our costs over the past year.

And while that discipline will remain, it's also about taking the next-step and doubling down on cultivation, as we mentioned. In my opening remarks, I mentioned three pillars on that. And that's really around people, process and plants. And it's in that order for u. It's very, very important. We have new genetics that is coming to market in Q4.

We're excited about that. We're taking our existing commercial strains. And we're streamlining that. And that's part and parcel to what we mentioned in the remarks as well, around our SKU optimization. It's all about simplifying the supply chain. We're seeing some of our counterparts go the opposite way.

And I don't think that's needed, especially if you want to play in the corner of the premium segments. You have to earn your right to win there. And that's really what we're focused on, in the facility on the operations side. Hopefully, I provide some color for you Pablo..

Thank you. And that's very helpful.

Can I ask, maybe just one more? When I talk to the many companies how they are -- I find that there are different strategies when it comes to strains, right? There are some companies that if I look at this kind of data, almost 40% or 50% of their flower business, may come from just one strain, right? Whereas, the other companies would have a more diversified strain portfolio in terms of strains.

And then, there's a third category that, I consider the limited-edition companies that have a strains for the season and then, they change them later on. And I'm just trying to -- I suppose, they all make sense. But do you have a view on, what's better right now, or there are just different strategies and to each their own? Thanks. I'll pass it on..

Hi Pablo its Andrew, a good question. Look, we're big believers in focus on core, get that right. And then, earn your right to you know move into more diversification in your product portfolio. So first and foremost, we've got to make our current commercial genetics work, but we also know consumer preference moves overtime.

And certainly, what we've seen in more established markets out of the U.S. that cycle is you know six to nine months. And you can really get a good strain and drive that forward. But then, you're going to have to come in with a good innovation pipeline. And that process, given that we're in agri-foods business, it takes time to run that R&D cycle.

So genetics will be a key part. And that's part of my three-pillar kind of process, I laid out there. Plans being the last piece of that, it's going to be a key part of our folks to move forward.

And we have the facility with the small-batch scale capability to run that play, but I would say, primarily focus and I mentioned in the SKU optimization issue. We got to get the core right. Our customers are asking for it. I think consumers are looking for consistency in cultivation. Again, I think, we can deliver on that.

That's what we're focused on in the short-term here..

Got it. Thank you..

Our next question comes from Vivien Azer of Cowen. Please go ahead..

Hi. Thanks very much. So Zach, I just wanted to pivot back to the portfolio clean-up that you guys engaged in the quarter. So it makes sense that you would discount the Grasslands product move it through the system, so that you guys can now have a better footing, as you orient toward profitable market share versus market share at all costs.

But as I look at your balance sheet, it looks like your inventories grew about 30%, over the course of the quarter.

So can you help me reconcile that?.

Yeah. Thanks Vivien. I'll let Andrew talk about inventories and how that's feeding operations into Q2 and beyond..

Hey, Vivien, thanks for the question. Yeah, absolutely, I think, when you have a $10 million top-line number and as we grow out, I think, that's a big focus for us.

So the best way for us to manage that inventory level to a sustainable rate is, we want to have at least two to three months of inventory on hand, sellable inventory, the right quality inventory. And we're proactively managing that as best we can given, our cultivation focus.

And we've also got obviously a dynamic in the industry with provincial boards, trying to get their weeks of coverage in inventory under control. So it's very dynamic. And it's certainly an area of focus for us. And it's very much predicated on our ability to grow, a consistent quality product that consumers and customers want.

Once we do that, we can drive that top-line number up and certainly you get that inventory level to, where we needed to be, which is you know about two to three months associated..

Got it. And then, just to follow-up on that, then, Andrew. Presumably, the inventory that you guys have on hand is better quality that you guys talked about the improvements in potency year-to-date.

So then, how do we think about, gross margin go forward? Was the negative gross margin in the first quarter truly a one-off and how do we think about recovering gross margin? Thanks..

Yeah. Thanks Vivien. Good question. Look I think the gross margin is certainly not across the entire portfolio. I think that's the first piece I'd mention and there's certainly a pretty large range there on how we look at inhalables and the margin profile that we're able to drive.

But look maybe I'll touch on a couple of pieces and then if Jim and Zach want to add in please feel free to do so. But the big one is we saw further price compression in the quarter. I'm not going to believe that point it is what it is and we're seeing that across the industry. We had some discounts and allowances as well as some returns.

And that was really proactive for us, because obviously the ability to manage the right assortment at a store level starts at what is in-stock at the provincial level. So we want to make sure the freshest and highest potency product is there. So we were proactively managing that.

We had some discounts and allowances and some returns that we had to manage through a normal course of business. But as we get tighter on our inventory, provincial boards get tighter on their inventory and get more selective on their SKU assortments; we're certainly in a better position to manage that moving forward.

And then my last point I'd say if you look at gross margin, we did have some cultivation production variance in there due to increased power charges that we saw largely in February. And that's tough to manage given our fixed cost base in our asset in Olds.

But we anticipate that to be one-time factors and certainly we'll see that bounce back as we come into Q2 and the balance of the year.

But I'll pass it to Zach and Jim, do you want to add anything to that?.

Yeah. This -- Vivien this -- the point on our utility cost is an important one. So we actually saw in the month of February, our power prices effectively doubled. They're back down to basically January levels now, but that was a painful spike that impacted our cultivation and processing costs..

Can you quantify what the magnitude of that incrementality on the energy cost was?.

Yeah. It was approximately $300,000..

Okay, understood. Thanks very much..

[Operator instructions] Our next question comes from Shaan Mir of Canaccord Genuity. Please go ahead..

Hi and thank you for taking my questions. My first question is just on some commentary in the press release around the company seeing an increased sales trend for wholesale markets. I was wondering if you could detail some of the developments that you're seeing on that side particularly as it relates across the different pricing spectrums.

Where are you seeing that resurgence of interest? And then also if I tag on, how does Sundial expect to approach this segment of the market going forward? What should we expect from a branded product versus wholesale mix in the balance of the year? Thank you..

Hey Shaan, it's Andrew here. My apologies. That first piece of the question cut out for me.

Would you mind just repeating that and I'll take it from there?.

Yeah sure. So the first part was just on some of the commentary that was in the press release regarding increased sales trends on the wholesale market. So I'm just wondering, if you could detail some of the developments that you're seeing in those wholesale markets particularly as it relates to a different price -- product pricing spectrum..

Got it. Got it. Okay. Thanks. Yes, it's actually really interesting. Where seeing kind of a full 180 when it comes to demand on B2B, kind of, wholesale side of it. You know as we stated we're seeing a lot of our peers you know simply divest from cultivation.

And you know that's driving a lot of interest in producers that can do that at scale and Sundial is certainly well-positioned to take advantage of that. So I would say that you know the early days of kind of you know when we went legal here in Canada you know we had a huge demand there on wholesale B2B.

And I think you know we saw that kind of taper off a little bit in 2019 to 2020 and we're seeing that come back full force. So I think that's really positive for us given our small-batch-scale approach and our focus on cultivation.

And I would say when it comes to the pricing side of what we're seeing in the market, you know, it's the same thing we're seeing on the retail side quite frankly. You know everybody wants you know above 20% THC. And you're starting to see a pretty big you know floor there when it comes to the ability to monetize and get products above 20%.

So if we can get above 23% to 25%, you know, we're seeing very, very healthy margins on that side. But again, you know, nobody's really doing that at scale and there's a lot of larger companies that are really wanting maintain the right product coming in.

And they just can't get that consistency through the different markets in which we're able to procure that product from at the prices they need to get at given that the supply is pretty short in that high-potency range. So I think that just gives you another bit of color there.

In regards to what does it mean for us I think it's just -- it's -- it was the core focus of our business early days. We made a pivot in 2020 to really about 80% branded 20% wholesale. You know we're still focused on the branded side, but we're going to be advantageous as it makes sense for us in our business as we have more of these conversations.

And we look at you know scaling appropriately with the right cultivars and the right partnerships on the wholesale side..

Thank you for the color there. My second question is going to pivot to talking on the cultivation and production costs in the month. So you noted that average production and cultivation costs per month came down to $4 million in the quarter versus $10 million last year.

If I remember correctly from the Q4 reporting, I believe that figure was down to CAD 2 million per month on a monthly basis. So just trying to get an understanding for why the sequential increase on that front and how that played into your margins.

And then also if there's any sort of forward commentary maybe detailing relative to Q1 where you think a sustained average cost level is. I'd appreciate that. Thanks..

Jim, do you maybe want to touch on that? Because of same of changes you made in C&P?.

Yes, sure. I'm happy to. I think as Zach mentioned, we had some elevated costs. And I think he only mentioned one aspect of that. I think we saw some other non-recurring elevated costs in that we did a complete replacement of -- in many of the grow rooms of the lamps.

And then we had some other processes that we accelerated testing and other aspects that we accelerated that were on a temporary basis. So it's you know the total number that I think we look at in terms of non-recurring costs was about CAD 700,000.

And I think we had to be clear also when we speak about the COGS numbers that you're referring to and the cost of C&P, as some C&P costs of course are sitting now in the inventory as we talked about in the previous question. So not all of those are flowing through to our income statement.

But I think that we'll -- we expect that we'll get down to a more normalized level of you know something in the range of $3 million to $3.5 million a month on C&P costs..

All right. Thank you for the color and that's it for my questions..

This concludes the question-and-answer session. I would like to turn the conference back over to Zach George for any closing remarks..

Thanks, operator and thanks to everyone for joining our call today. We look forward to updating you in the coming months. Stay safe..

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