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TerrAscend (CSE: TER) (OTCQX: TRSSF) is a Canadian public company with operations in Canada and five U.S. states: California, New Jersey, Maryland, Pennsylvania, and Michigan, where it has its greatest concentration of retail outlets. A vertical integrated company in each of its U.S. markets, TerrAscend operates 34 dispensaries, and just announced the acquisition of a second already existing store in Maryland, bringing its overall total to 35. Like many MSOs, TerrAscend has been reshaping and reassuring its footprint of late, and just announced the sale of its Mississauga, Canada facility for CAD$19.7 million, leaving the Toronto dispensary its remaining Canadian asset.
In addition to retail, of course, the company has cultivation/processing facilities in each of its five U.S. markets and manages a number of CPG brands – Kind Tree, Legend, State Flower, Valhalla, Ilera, and Original Hemp – in addition to maintaining and expanding exclusive partnerships with major brands Wana and Cookies. TerrAscend also recently announced a partnership with Dablicator, a California-based manufacturer of cannabis hardware, to feature the Dablicator™ Oil Applicator with the company’s Gage Cannabis, Kind Tree and Ilera Healthcare brands.
Founded by others, the TerrAscend of today is the creation of Executive Chairman Jason Wild, whose JW Asset Management made its first strategic investment in the company in 2017 in partnership with Canopy Growth, and remains a significant shareholder. TerrAscend began its ascent into the growing U.S. cannabis market in 2018 by acquiring The Apothecarium chain of dispensaries in California, gaining a license in New Jersey, and then continuing to build on that momentum over the intervening years by making targeted acquisitions in the states it now calls home, as well as in markets that did not quite pan out, like New York.
The company has had changes in executive leadership along the way as well, but in March the board made the decision to promote then President and COO Ziad Ghanem, who joined the company in January 2022, to CEO. It was a vote of confidence in the ability of the longtime Walgreens executive to maintain stability and efficiency within the company as it seeks to reduce debt and increase free cash flow during this period of uncertainty for the industry as some markets are seeing growth while others are constricting, and stasis continues at the federal level.
“When I joined the company as President and COO, we did not have a CEO, but I did report directly to the executive chairman of the board and to the board,” said Ghanem during a recent interview with Cannabis Business Executive. “Coming in, I had a clear vision of what we would like to be as a company, and the promotion is just a shot of confidence from the board and the executive chairman. The thought has always been I’ll join the team, integrate with the culture, understand the team, and I’ll build a team that will transition into that role. That was the vision from the beginning, it just progressed naturally, and I’m humbled by it.”
When Ghanem first joined TerrAscend, the previous CEO had left the position less than a year before, and Wild as the executive chairman had jumped in and supported the team, said Ghanem. The transition since then has been smooth. “My responsibilities as President and CFO, and the progression into the CEO role, have been the same,” he said. “The team that reported to me prior to that point is still the same team I have, and the leaders of each market reported to me in the past and continue to report today. The CFO, the chief legal officer, the chief HR and people officer, the IT leader, and the marketing leaders continue to report to me, so it was a two-step process to come in and integrate the business units to reengage and progress into that structure.”
Following a career at Walgreens that included about a dozen different roles at the corporation, Ghanem worked with the private equity group called Parallel. “I spent the year there before I joined TerrAscend,” he said. “In that cannabis experience. I was the president for all operations.”
A pharmacist by training, he said he spent half of his career at Walgreens focusing on three areas where he had several different roles in each area. “The first area was operations,” he explained. “The second area was strategy and innovation, and the third area was product launch and the pharmacy of the future.” It was a period when the pharma industry was growing rapidly. “There was a period between 2003 and 2007 when we opened one pharmacy every 19 hours,” he said, adding that it was not dissimilar from the cannabis industry.
“Having done that rapid growth and building, I saw a lot of similarity in cannabis,” he added. “I found that I bring a lot of value doing the same thing I’ve done in my first half of my career and bring it to a young and exciting industry that is growing very fast. On the personal side. I have unfortunately been part of an opioid pandemic that has caused seven overdoses per day in Florida, where I live. I have seen major struggles for patients who had sleep, anxiety, etcetera. When I started getting interested in cannabis from a career perspective, one of the most impactful things for me was witnessing again and again patients who have replaced five sleeping pills – between oxycodone, Lunesta, Xanax, Soma, or Ambien – with a five-milligram gummy. That was so powerful as a pharmacist, and from a career perspective and from a purpose perspective I brought those two things together, and that’s what got me excited about the transition.”
The similarities went deeper than he realized. “When I was doing my homework to make the decision to join cannabis, I did a lot of interviews with individuals who had made the transition, and I quickly realized that the stakeholders that exist in cannabis that you deal with on a daily basis, and the stakeholders that exist in pharmacy, for example, or any other business, are exactly the same,” he said. “If you follow the product or if you follow the finances, you basically have the exact same patient and customer, but they just do different stuff during the day. When you think of the employees, they are the same employees, whether it’s a technician or a budtender, or whether it’s a finance professional or an IT professionals, those are the same stakeholders. When you think of the P&L in the balance sheet, it is absolutely no different whether you’re selling a pharmaceutical drug or a cannabis product.
“Then you think of the regulators, and they’re exactly the same,” he added. “In Pennsylvania, the same Department of Health that regulates pharmacies regulates cannabis, and it’s the same for Florida and many other states. They are also the same exact investors, so the similarity between the two businesses, when you follow the money or the products, is exactly the same. And the common skill that is needed to lead effectively in both areas is the ability to flex up and down and to be agile. To in the morning be able to engage and share a vision with a team member that is a high school graduate or a young college graduate, and in the evening be able to flex-up and talk to a senator or a congressperson. The skills are really the same, and the experiences I had were extremely helpful with that transition.”
And large trends, like consolidation, are also a feature of both industries. “The similarity is pretty profound on the consolidation part,” said Ghanem. “The pharmacy industry in particular has gone through major consolidation driven by price pressure and reimbursement pressure, whether it’s Medicare or private insurances. In the cannabis industry, consolidation is driven by the cash burn that exists in some businesses that overwhelmed themselves with long-term debt like sale lease-backs and other high interest loans.
“As the states mature, the need to build an efficient operation and a sustainable business based on solid guiding principles is a must,” he added, “especially when you have a major differentiator between cannabis and any other industry, including pharma, which is the punitive codes that exist in cannabis. When you think of 280E, when you think of the banking codes, and when you think of the punitive business anchors that you have to deal with every day, it becomes that much more important to be strong on your business principles in order to be successful.”
That part is very similar, he noted, but what takes cannabis to another level of challenge is the rules and regulations around packaging and what you can do in one state versus another. “In the pharmacy world,” said Ghanem, “the packaging could be the same everywhere, whereas in cannabis, my label cannot be the same in Pennsylvania as it is in New Jersey or in Maryland. It adds another layer of complexity when it comes to operating expenses, and it makes it that much harder to get the synergy of scale that you have in different states.”
Finding Efficiencies
For Ghanem, the trick to becoming more efficient is found at the local level. “I don’t think it is an option but a must to have an effective and efficient operation,” he said. “And the way to do it is to look at every business unit independently based on the state and the regulations. My vision has been, whether it’s a New Jersey that is new and exciting and where things are going extremely well, or whether it’s a more mature market like Michigan, every business unit in every state has to stand independently on its own from an EBITDA and cash-flow generation perspective, and that is the focus that the team has started since day one when I joined and will continue.
“I would say we led the industry with some of the reductions that we have made that resulted in our Q3, Q4 and Q1 performance and the improvements that we have made,” he added. “So yes, we are acclimating, we have to, and it’s across every line, starting with the COGS and making sure that you optimize your packaging, your raw material, your fixed costs, and capitalize some of that costs through smart automation. It goes down all the way to balancing your quality and price in order to protect margins, so your costs continue to be at a level that is proportionate to your revenue.”
For years, many MSOs were fixated on growth over efficiency, a strategy that has not been kind to balance sheets in a constricted economy. When Ghanem joined TerrAscend, did he find a company that needed to go on an aggressive weight loss program in order to stay afloat?
“I think we were we were fortunate,” replied Ghanem. “We have three things that differentiate us from any other MSOs. I’d like to cover them very quickly, and then I will break down where we have some fat, which was mainly through some of the acquisitions that we’ve made. But about the three things that really set us apart from others, number one is the lineup of the states that we have. We have New Jersey, which 13-14 months ago went from medical to recreational, and we have had five quarters of sequential growth because of New Jersey; we have Maryland that has gone recreational, which will give us four to six quarters of sequential growth. And then, similar to what we started with New Jersey and Maryland, we expect Pennsylvania to go recreational. So, those three states on their own will allow our topline revenue to double from where we are today, and that is super exciting.
“The second differentiator is the open map that we have in front of us in a buyers’ market,” he continued. “We currently are having conversations that are extremely attractive, and often we’re not talking with the leaders of the company; we’re talking with the lenders who are dealing with either pre-default or pre-receivership and are willing to make deals that are extremely attractive. But we continue to be disciplined to catch the right deal that fits within our vision.
“The third differentiator is the sponsorship that we have,” he added, “not only in the obvious support that we get financially with Jason and his group owning 80-plus million shares, but the support that we get from the investor community and the support that we have seen in the past and we continue to see. So, for those states going recreational that I listed, we did not have to go on a diet or a cut. Michigan was built-out for the future prematurely, and as we announced in one of the earnings calls, we went on very aggressive management where we reduced op-ex by 30 percent or so in Michigan. So, yes, [we cut] when it was needed, but fortunately, because of the growth through recreational dynamic, we did not have to do it throughout the enterprise.”
California is somewhat of an anomaly for TerrAscend, which has not quit the state like other MSOs have done, but still maintains a relatively small footprint. “In California, we only have five retail stores, and then we have a small grow that produces around 300 pounds per month,” said Ghanem. “While California does not create cash burn for us, it is the most cannabis-mature state in the U.S, and we learn a lot from it from an R&D perspective. With the small grow that we have in San Francisco, for example, we have managed to reduce the cost of production per pound to the lowest in the nation, and this is in a city where labor costs are very high compared to Michigan and other places. With some of the things that we try, we prove the concept and then we teach it across our enterprise, so California is standing on its own as a Petri dish for us.”
Uplisting to the TSX
In its recent Q1 earnings report, TerrAscend had GAAP net losses despite an increase in net YoY revenue, but the losses were attributed to “a $21.2 million reversal of goodwill and intangibles impairments in the fourth quarter of 2022 related to the finalization of the acquisition accounting for Gage.”
Otherwise, the company reported its sixth consecutive quarter of sequential revenue growth and third consecutive quarter of positive and increasing cash flow from operations. It also generated positive free cash flow for the first time since the first quarter of 2021, its gross profit margin improved 420 basis points sequentially to 48.8 percent, and it reported progress towards an anticipated Toronto Stock Exchange (TSX) listing upon shareholder vote on June 22. Its latest financials also indicated the company has almost $33 million in the bank as of March 31, and free cash flow of $6 million. So, how can TerrAscend take advantage of the many great M&A deals that are out there waiting to be consummated.
“From an M&A perspective, our top priority is to be fully integrated in Maryland,” explained Ghanem. “We had one retail store, today we announced the second, and as we shared on our earnings call, we plan to go fully vertical soon and have the maximum allowable number of stores, which is four. So that’s one of our top priorities.
“Our second priority is going deeper in Michigan,” he added, “and the reason why is we had infrastructure in Michigan from legal and finance and shared services like marketing, etcetera. So, any acquisitions we make in Michigan, and the deeper we go by acquiring retail stores, will be efficient revenue that comes with only 10 to 15 percent op-ex versus the 30ish percent you usually have, and that op-ex is only coming from the retail labor and from any store leases.
“As we watch Pennsylvania getting closer to going recreational,” he continued, “the third priority will be to repeat the same playbook that we are doing in Maryland, where, especially with the cultivation center that we have, we will acquire additional retail stores. So those are our priorities from an acquisition perspective. What is helping us from the cash perspective is that we don’t have a big number that is needed for capex. Pennsylvania is built out, Maryland is built out, New Jersey is the only place we are expanding, and in 2023 it’s going to be around $10 million or so.
“About cash, we acquired one of Maryland’s top performing medical dispensaries today, which is doing around $14 million in revenue,” he noted. “Located on the border, we expect this dispensary to actually become the number one store out of our 35 locations, and if you look at the amount of cash that we paid for it, it’s close to a million dollars after adjusting for working capital and inventory. So, a lot of the deals are cash light, and that is because we sit today in the capital market. Something helping us a lot is that sellers are looking at our stock as a currency, and that is because of the TSX uplisting that is coming. We’re still on track to uplist to the TSX in the first week of July, and if you combine the increased liquidity that happens on that exchange and the strong business principles that are causing us to be free cashflow positive from operations, some of the sellers look at getting equity from us as a currency.”
In terms of the growth necessary to make the pieces fall into place for TerrAscend, Ghanem sees organic growth as the answer in New Jersey, Maryland, and Pennsylvania. “Maryland is going to be bigger than $100 million potentially for us where today is a single digit revenue generator,” he said by way of example. As to how the company will get from single-digit revenue to $100 million, “It is the limited license, the four stores, and the wholesale business,” said Ghanem. “Our brand strategy has been to go as vertical as we can with our stores carrying our brands, and adjacent to them we have our partner brands that are traffic drivers and loyalty builders, such as Wana and Cookies, so that same brand play we’ve done in New Jersey will repeat in Maryland.”
Regarding branding and the consumer/patient, Ghanem sees a period of time when relative confusion will prevail. “In an environment that continues to consolidate, at what point will that consolidation stop and you become one brand,” he said. “In my opinion, until the consolidation stops, you’re going to continue to bring in different brands under the umbrella, but the grand strategy in our store will continue to be the same, and it’s proven to be extremely successful.
“It is a two-prong strategy,” he explained. “One is it’s a specialty product, a premium product, that is sitting next to familiar brands that are all vertical, so we believe that there are no mid-tier brands. It is either premium quality or a value brand. In my humble opinion, a lot of companies try to create that mid-level tier, but it gets squeezed by the other two sides. There’s a case study in Canada that shows that it has failed miserably, so we are stubborn about it, and it’s bringing us huge loyalty with our customers. Adjacent to that as I mentioned we have premium brands that drive traffic and increase the loyalty trends as they sit next to our brands, but the brand-facing continue to be complex and costly, because we are not one brand, and we are not one package.”
As the shareholder vote to uplist to TSX approaches, Ghanem had a few additional observations about the equity markets. “One of them is company related,” he said, “and the other two are macro-environment. The first one is that I think investors have become savvier and have learned about the industry as it has gone through its ups and downs. Currently a company must prove that EBITDA is not the only number. Cash flow from operation and free cash flow is the real metric and is the real attraction. The efficient performance of a company is also a must, and that is going to put a lot of pressure on some of the companies that are behind because of some of the decisions in the past that were made on the balance sheet. Of the other two macro environments, I believe one of them is the capital market and the interest, and the other one is 280E, and those are obviously legislative initiatives. There’s also a lot of optimism around what’s happening with SAFE banking and what could happen in June, and we are excited and think it will help break down the bias that exists around cannabis, but we plan for the worst and hope for the best.
“That’s why at TerrAscend, over the last three quarters, we have focused on reducing our debt, and over the last two to three quarters we have removed $90 million off of our balance sheet with debt that we equitized with Canopy Growth, and we have paid down our debt in Michigan and become one of the top two companies when it comes to debt ratio to revenue. That’s something we are super proud about. We were able to cut our interest in half as we exited 2022, and that is how we are gaining control of our cash generation, and reducing interest as we wait for breaks on the 280E tax.”
I asked Ghanem what metrics keep him up at night. “There’s only one and everything is attached to it: positive cash flow from operation,” he answered without hesitation. “That is true north for me and for the group; how do we continue to be as good as anybody could be when it comes to positive cash flow for operation. In order to do that, you start with the COGS, and you have to have a reduced cost of production. You go with the price, and you have to stabilize the price, and our strategy around our brands is helping us accomplish this with premium pricing. Then you go down to op-ex and manage that by spending every penny when revenue comes in, and not before. Those are the operational metrics, they all contribute to the cash flow, and then below the EBITDA line, there is interest and tax. Nothing we can do about that, interest is where we get the biggest accomplishment, so that’s how we got to the positive cash flow from operations that we have had over the last two quarters.”
TerrAscend does not give guidance to the street, but Ghanem was willing to talk about how the company looks at it. “You do a yearly three-years plan, where you look at the year and you look at state-by-state and then you forecast the growth, the pricing, the retail doors that are opening, cultivation that is coming online, and you look at that year-by-year, taking into consideration states like Maryland flipping into recreational,” he said. “That’s the easy part, and often, when you’re two or three weeks into the quarter, you can forecast the quarter, and I’ve been excited over the last couple of quarters because we’ve been meeting consensus on revenue and EBITDA. From a three-year plan perspective, it’s more about strategic planning and less financial planning, which is more about growth. Strategy is about which markets to consider, what are the priorities of growth, what are the opportunities that are available, things like that.”
Shedding Tiers
As TerrAscend solidifies its positions in the markets it is in, I wondered how Ghanem sees the company in relation to its peers, but he was resistant to the notion of tiers. “I don’t understand tiers,” he said. “Is a tier based on revenue, is it based on balance sheet, is it based on cash-flow generation, or is it based on ratio? Because there are a few of those that are mentioned that put us at the top two or three companies from a performance perspective. Some of my peers look at revenue and say, ‘Hey, if you’re around a billion dollars [market cap],” so I really would love to know so I can tell you where I see us.”
Given that, how does Ghanem evaluate the strength of a competing company? “I’m going to focus on TerrAscend because I eat and breathe and feel it every day,” he replied. “I evaluate its strength, first by the growth, second by the balance sheet, especially around debt, and then third, by the cash-flow generation from operations. And I will tell you with a lot of humility – and I know the industry extremely well now – there is no other company I’d rather be leading today than TerrAscend, and I will give evidence why from a growth perspective. When you look at the growth chart for each company, we are at the top of the lineup from a percentage perspective, and I think over the next four to eight quarters that we will double in size and revenue just in the states that we are sitting in without talking about any new acquisition or state.
“So, from a growth perspective, I feel pretty fortunate and extremely excited about this,” he added. “From a balance sheet perspective, we don’t believe in carrying cash on the balance sheet just to feel safe. We have made some tough decisions where we said no to a $50 million sale leaseback in Pennsylvania because we still take great pride that we don’t have long-term debt, so the debt-reduction that we’ve done is something I’m super proud of. And cash generation with the lineup of the states that we have is the third thing. So, it is the combination of growth, cash from operation, and debt on our balance sheet, that tells me where the strength of the company is, and if you compute those in any manner, I think we’re at the top of the chart.”
Do those estimable strengths make TerrAscend a tasty target for an acquisition? “I don’t think so, because of the limited-license states that we are in,” replied Ghanem. “If you look at New Jersey, Maryland, and Pennsylvania, those are not unlimited states, and the majority of the players exist in that market, so the answer is no when you think of it like that. Now, as the industry progresses and as reclassification or declassification takes place, and as more interest is out there, time will tell how we will grow, but as of now, we’re focusing on our growth over the next two to three years, and that is looking extremely attractive to us.”
Does he expect to see any big player deals in the near-term? “I think we’re right-sizing right now,” said Ghanem. “Some deals are falling apart because the industry is moving quickly and what you agreed to 12 months ago is not the same environment we sit in today. I dislike what I’m about to say, but before we see more companies coming in, we’re going to see more companies and more players exit the industry. We are seeing cultivation reduction in states, and we’re seeing retail growth slowing in states.
“If you compare Michigan and New Jersey’s first 12 months post-adult launch, you see totally different stories,” he added. “The equation is the growth of the market versus the growth of cultivation coming online versus the growth of retail stores. Anytime you have a market growth that is outpacing the retail doors that are opened, and the cultivation sites that are coming online, prices are stable, and businesses are booming. Three or four years ago, because of the excitement of cannabis and because the capital markets were in a totally different place, often in those states you saw cultivation and retail doors outpacing the growth of the market, and that impacted prices tremendously. Today in New Jersey, 14-months post-lunch, we still are seeing the same margins that we saw 14 months ago, and that’s driven by slower retail growth than we would like to see, but then noncapital investment coming in for cultivation that brings in that extra supply.”
I noted that Ghanem had not mentioned challenges from the illicit market. “I think today it is still a big market, and an unfortunate situation,” he said. “The part that hurts demand is that the regulators and state sometimes make decisions that are too slow or lack vision, and that allow the illicit market to grow. You can go to New York and see what the slow decision-making of the state is causing on the street from an illicit perspective. But here’s my hope, and here’s where I am optimistic when it comes to the illicit market. You have more and more adopters, you have a younger generation that is looking at cannabis as a safe industry that is growing, and the option is to deal with illicit market or to buy safe, tested, competitive-priced products that the Department of Health or the CRC has blessed. I believe that over the next few years ago, we’ll see bigger and bigger migration into the regulated industry and more and more pressure on the illicit.”
Regarding another attempt to conquer New York, Ghanem said, “We’re watching, we’re learning, and we are not having any FOMO.” Similarly, with respect to Massachusetts, “We’re watching,” he said, “but we believe in entering a market either with a sizable acquisition or with a first-mover advantage. We just don’t believe in coming in late in an advanced cycle of the state.”
Neither is international expansion currently in the cards. “We do not have any international presence, and it’s practically not a top priority for us,” explained Ghanem. “We believe there is plenty of low-hanging fruit ahead of us over the next two to three years that we’re laser-focused on, and those are the states that I shared with you and the opportunities that we see here.”
I noted that despite not providing guidance, it sounds as though we can expect to see a different TerrAscend a year from now, a more robust company, a different company. I asked Ghanem is he could agree with that statement. “100 percent,” he said.
As far as any additional messaging he had for the industry, “We just want people to know about our cash-flow generation, our growth story, and our debt and balance sheet story,” said Ghanem. “That’s really what we’re focusing on, and that’s what we plan to continue to do over the next two to three years.”
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