Third Quarter 2026 Results Conference Call - VALENS COMPANY INC

Financial Performance:

• Third quarter 2026 net revenue was C$238 million, a 2.5% decrease year-over-year, driven by declines in liquor retail and cannabis operations offset by growth in cannabis retail.
• Gross profit was C$57.9 million, down 9.8% YoY, with overall gross margin contracting to 24.3% (down 200 bps) due to severe underperformance in cannabis operations despite record margins in retail segments.
• Reported operating loss was C$48.3 million, including a C$52 million non-cash goodwill impairment on cannabis operations.
• Adjusted operating income was positive C$5.2 million, representing a C$14.8 million improvement YoY, excluding impairment charges and restructuring costs.
• Free cash flow reached a record C$20 million (up 19.5% YoY), supported by a C$10.6 million one-time benefit from the initial unwinding of the captive insurance arrangement.
• Cash and cash equivalents decreased by C$50.7 million, primarily due to C$60.8 million in capital contributions to equity-accounted investees and C$10 million in share repurchases.

Guidance and Future Outlook:

• Management expects P&L benefits from workforce reductions at the Kelowna facility to begin contributing in the fourth quarter.
• A second and final C$8 million cash inflow from the captive insurance unwind is anticipated in Q4 2026.
• Anticipated resolution of Ontario alcohol and gaming regulatory matters is expected to normalize franchise operations, potentially leading to the deconsolidation of these assets.
• Deconsolidation of Ontario franchise operations is projected to reduce reported net revenue by approximately C$105 million but only reduce operating income by C$2 million.
• Strategic review of cannabis operations is ongoing to determine if asset divestitures or restructuring will optimize the segment's long-term value.
• The company aims to consolidate Sunstream's medical cannabis business into its recurring structure, pending regulatory clarity on Schedule 3 in the U.S.

Business Segments and Product Lines:

• Cannabis Retail: Net revenue rose 0.7% YoY to C$85.6 million (record level), with gross margin expanding 60 bps to a record 27.0%, driven by new store openings and value-backed conversions.
• Liquor Retail: Net revenue declined 3.3% YoY to C$134.8 million, impacted by a 6% same-store sales decline, though gross margin expanded 70 bps to a record 27.0% via pricing and mix management.
• Cannabis Operations: Net revenue fell 27.7% YoY to C$27.0 million; the segment exited the unprofitable domestic dried flower category, resulting in a negative gross margin of 6% and a C$1.6 million gross profit due to inventory adjustments.
• U.S. Investments: Indirect equity ownership in Parallels increased from 67% to 92% following a rights offering; funding was allocated to a new cultivation facility in Gainesville, Florida.
• Strategic Actions: Implemented a workforce reduction of over 30% at the Kelowna facility and initiated a strategic review of the cannabis operations segment.

Market and Competitive Landscape:

• The domestic dried flower market is characterized by intense competition from LPs with large-scale hybrid greenhouse infrastructure, making high-cost indoor production uncompetitive for Sundial.
• Liquor retail faces persistent market demand softness, though private label sales outperformed national brands by 8.5 percentage points.
• Cannabis retail same-store sales declined 3.8% in Alberta and Ontario due to market contraction but were offset by new store additions.
• Sundial maintains a dominant position in edibles and beverages, focusing on distribution of branded products and profitable license relationships.
• The U.S. market presents opportunities for indirect equity and debt exposure while awaiting regulatory resolution for direct consolidation of recreational assets.

Risks and Challenges:

• Cannabis operations continue to underperform expectations, dragging down consolidated margins and necessitating potential asset divestitures.
• Inventory adjustments associated with the exit from dried flower production caused significant short-term financial headwinds in Q3.
• Market contraction in key Canadian provinces (Alberta, Ontario) continues to pressure same-store sales in cannabis retail.
• Regulatory uncertainties in the U.S. regarding Schedule 3 and state-level legalization create timing risks for direct capital deployment and consolidation.
• Liquor retail remains vulnerable to persistent softness in consumer demand despite margin improvements.

Management Commentary and Tone:

• Management conveyed a tone of disciplined optimism, highlighting record free cash flow and positive adjusted operating income despite significant sector headwinds.
• CEO Zach George emphasized "decisive action" to simplify the portfolio and return to profitability, acknowledging that significant work remains in cannabis operations.
• CFO Alberto Paredero reinforced the focus on financial discipline, cost control, and the strategic value of maintaining a debt-free balance sheet and investment portfolio.
• The company expressed confidence in its ability to improve operating performance and create long-term value through selective capital allocation and operational improvements.

Analyst Questions and Answers:

• UGMP Certification: Management confirmed the facility passed the EU-GMP audit; certification is imminent and critical for reducing reliance on external processors ($0.20–$0.45/g cost savings) and improving yields for international markets via facility upgrades.
• Exit from Dried Flower: Management explained that high-cost indoor production cannot compete with low-cost greenhouse producers in the domestic market; the decision protects margins without impacting sales in profitable categories like edibles.
• Strategic Review of Operations: Management indicated all options are on the table, including asset sales or restructuring, with a focus on improving operational execution and labor efficiencies.
• U.S. Capital Deployment: The company can currently deploy capital via the Sunstream joint venture and plans to consolidate medical cannabis exposures first, awaiting regulatory clarity before addressing recreational assets.

Other Key Points:

• Share repurchases totaled 5.4 million shares for C$10 million in Q3; since Q4 2024, 34 million shares have been repurchased for C$73.5 million, reducing shares outstanding by ~8%.
• An announcement was made for a potential substantial issuer bid of up to C$50 million to accelerate capital returns to shareholders.
• Sunstream acquired an additional portion of Parallels' take-back debt at 75% of face value, increasing ownership from 39.4% to 69.4%.
• The company expects to deconsolidate Ontario franchise operations upon resolution of regulatory penalties, transitioning to a modified franchise structure.