Stay positive on Sunniva (CSE: SNN)

QUESTION: “The Sunniva announcement that the Canadian facility is suspended means the Canopy Growth agreement is over. Add to this all the delays in both Canada and the U.S. How are investors supposed to stay positive? There has been a lot of opportunity lost. Have you changed your opinion on management?”

T.N. from Vancouver, B.C., Canada

ANSWER: Let me answer your questions one at a time and conclude with an interview I had recently with Dr. Anthony Holler, co-Founder and Chief Executive Officer of Sunniva (CSE: SNN) (OTCQB: SNNVF).

The suspension of the Canadian facility build out and the Canopy Growth agreement have become less relevant as SNNVF’s focus became more and more concentrated on California and less and less on Canada. As Dr. Holller said during the interview, he expects the remaining Canadian assets to be sold in the near future. If the stock you own in a portfolio does not perform as well as expected there is certainly an opportunity cost. But you can’t drive your car or manage your portfolio looking only in the rear view mirror. I admit the investment performance has been disappointing but the message I got from Dr. Holler is don’t throw in the towel now.When things have not gone as expected, it’s hard to stay positive. It is hard to take the emotion out and have a totally dispassionate look at SNNVF but that’s what you have to do. If you had never heard of SNNVF and found it today at its current price, would you invest? Dr. Holler gives us a complete update below and again, I come down on the side of optimism. A big part of the reason I rate the quality of management to be so important is just in case something goes wrong. You learn a lot more about people by how they respond in times of adversity. I like what management is doing: they remain positive, aggressive and convinced their strategy will work. As an investor, if doubt creeps into my thinking, an interview like the one below restores my confidence in SNNVF and its management.

On May 6, 2019 I interviewed Dr. Anthony Holler, a Co-founder, Chairman of the Board and Chief Executive Officer of Sunniva Inc. Dr. Holler is the Independent Chairman of CRH Medical Corporation. Dr. Holler was a co-founder and served as a Director of ID Biomedical from March 1991 and Chief Executive Officer at ID Biomedical Corporation from March 2001 to December 2005 and also served as its President. ID Biomedical was a leader in high quality, low cost manufacturing of flu vaccines that was sold to GlaxoSmithKline in 2005 for $1.7 billion. He has served as an officer and director of many other private and public companies.

Dr. Holler invests in and takes an active role in every company he works with. He is engaged full time by Sunniva with a focus on increasing shareholder value.

Dr. Holler served as an Emergency physician at University Hospital at the University of British Columbia. Dr. Holler is a Member of the British Columbia College of Physicians and Surgeons. He holds a Bachelor of Science and a Medical Degree from the University of British Columbia.

Ohashi: let me start by asking about the Canadian assets. I understand cancelling the spinout because it doesn’t really meet your requirements now that you are focussed on California. In your recent conference call, the Okanagan Falls project was described as “suspended.” That’s sort of in limbo.

Holler: some time ago we concluded operating in California will create more shareholder value than anything we can do in Canada. So our objective is to sell the Canadian assets and use the money to expand our California operations.

Ohashi: at this point the Canadian assets are the Okanagan Falls property and Natural Health Services. Is that correct? And it’s not a package deal. You will sell one independent of the other?

Holler: yes, we’ve had interest in them as individual assets.

Ohashi: how much are you into Okanagan Falls for?

Holler: I would say on the books by the time you take into account the property, the design, architecture and engineering – we’re probably into it for $20 million.

Ohashi: and you’re not going to get that out of it, right?

Holler: Well, I wouldn’t say that. If you’re interested in building out the property and there are parties looking at it that way, the design, contracts we have with engineering firms and suppliers – all those things are critically important. I don’t want to discuss specifics because we’re into discussions but you won’t have long to wait.

Ohashi: I have felt all along that National Health Services is a valuable enterprise. It has over 100,000 patients on its active list and at different points in time it has had up to one third of all patients registered with Health Canada. I don’t understand why Canopy or Aurora or any of the big guys aren’t falling over themselves to grab this business.

Holler: two years ago, I think I would have agreed with you. Now the College of Physicians and Surgeons in the provinces are basically saying, “We would never allow a pharmaceutical company to set up and sell their drugs directly to patients.” So I think we are going to see regulations saying you have to be agnostic to product, that is, an NHS cannot push one LPs product. This was built into our plan when we were looking at producing our own cannabis in Canada. We always planned to have, say, 20 different producers represented and we would be one. So the landscape is changing. Basically, what the College has been saying leads me to believe there are regulations coming. I don’t know why the College would allow a cannabis grower to sell directly to a patient when they don’t allow it with any other drug.

I agree the clinics are valuable but more to clinic operators. So there are a couple of things we are doing to improve the clinic business. We’ve aligned with UNIFOR, the largest private sector union in Canada, to educate their over 300,000 members and we’re working with some pharmacy chains to be their preferred referral for cannabis patients. For these reasons, I think the parties interested in NHS are companies that are in the clinic business already. Some Licensed Producers have gone into operating their own clinics so we’ll have to see how that all turns out. But I’ll say again, you won’t have long to wait.

Ohashi: the last I saw your patient numbers were over 100,000. Is that still where you are?

Holler: yes. Last year our patient numbers dipped because the College of Physicians and Surgeons said if you’re going to prescribe medical cannabis to your patients, you have to see your patients every three months. So we had to contact all our existing patients and tell them about the new rule and ask them to come in every three months. We had to do a lot of catch up. Now our numbers are growing again because we have a healthy balance between seeing existing patients and new patients.

Ohashi: if we cut to the chase do you think you’ll be able to sell your Canadian assets this year? In 2019?

Holler: absolutely! My gut feeling is these assets will be sold a lot sooner than that.

Ohashi: okay. Well, its early May already….

Holler: true but we’ve been working on this for a while and we do have interested parties.

Ohashi: the California operation is coming up on a year behind schedule. When I visited Cathedral City around a year ago and went through the plans in detail, it struck me as a highly automated system. But that also makes it complex to build. What is your view on the Cathedral City campus today?

Holler: I’m completely convinced we are doing the right thing with this facility. For example, I met with a consultant in Holland and we were discussing capital costs and cost overruns and he said, “Yes. But at least you’re doing the right thing. I consult to a number of operators who are converting large greenhouses and the problems with that are no secret. They are not airtight units like yours will be.” What he was saying is a converted greenhouse is growing inside a glass house. Our facility is completely airtight. I doesn’t allow contamination from external sources. We totally control what comes in and what goes out of our facility. They tell me, “Tony, you’re having some start-up issues and that’s frustrating. But in the end you’re doing the right things and you’ll be very happy.”

Here’s the other thing people have said to us. Because we have such tight controls, over time the quality of our product and the yield from the facility will improve.

Ohashi: let’s not skip over that because it’s important. What they are saying is because of the precise controls you have, over time the tweaks you make to temperature, humidity, nutrients and so on will improve your yield. You’ll not only get higher quality product, you’ll get more of it.

Holler: that’s right. I visited one of the largest tomato growing greenhouses in Holland. The person showing me the facility explained that the production from the facility has increased fourfold since they have operated it because they used diffused glass so the light comes in from everywhere plus technology that controls what happens to the plants and so on. He said we should get bigger numbers than we are estimating because our forecasts are based on what other people are doing right now. I think we are going to find with cannabis what those tomato growers experienced. This will come more slowly after we’ve been operating and fine tuning for a while but we will be like those tomato growers who were stunned by the large number of tomatoes they are getting out of the same facility.

Because of the ability we have given the computerized nature of our operation, we can go back and look at a particularly good or not so good crop and ask ourselves why that happened. We can learn to do more of what was good and less of what was not so good and I don’t think most people appreciate this potential.

Ohashi: But as I look at the California campus, it’s a year late or pretty close to it.

Holler: that’s correct. I don’t like pointing fingers but no one has built a facility like this before. Yes, there were some mistakes made over the construction period. There were also changes to the design. For example, we had two groups of consultants in to review cooling which is very important in Palm Springs. Losing one crop can cost millions of dollars. One Dutch consultant didn’t like the cooling system that was recommended. They said, “It might work. But you’re taking a large risk on a $100 million facility.” Then Barker Pacific brought in their own consultant and they agreed we were taking a huge risk. That led to changes that might end up costing an extra $15 to $20 million but we are now guaranteed that we can cool the facility even if the temperature goes up to 50 Celsius which can happen sometimes in Palm Springs.

As I keep saying none of this technology is new. It’s being used in many other places in growing. We have to fine tune it for cannabis. When that tweaking is complete and the facility is up and running, this is going to be the model for growing cannabis in the world. No one is going to have a facility that matches ours. Our people are going to be sitting at their computers and any problems are going to be identified instantaneously so we can correct it right away.

Ohashi: you were drawing some parallels between what you’re doing in California and what you did with ID Biomedical (IDB) that turned out to exceptionally successful and a big winner for investors….

Holler: with IDB, we built a high technology production facility for flu vaccines. The capital cost was considerably higher than what we’re spending in Cathedral City. When we finished, it was the most sophisticated and most efficient, large capacity facility in the world. The result was that GlaxoSmithKline purchased IDB for $1.7 billion. I saw a similar opportunity in cannabis and that is what Sunniva is all about. I’ve been here before.

Ohashi: so you are confident in your current timelines for Cathedral City?

Holler: In the last four months we have really concentrated on asking our consultants to give us a final time line and a final budget estimate. For instance, we are contributing an extra $10.5 million and I would argue that we don’t have to do that. But it was our commitment to the project and everyone working on it. And in a practical sense, it was more important for us to get this facility completed than spend time arguing about the $10.5 million. So we are comfortable with our expectations for time and money on the project because we have gone through and questioned everything. We expect the building will be completed at the beginning of July. Then we have to bring all the equipment on stream and test it to make sure we meet all the standards we have committed to. But I am very confident in our time line and if there is any variance it will be measured in weeks, in my opinion.

Ohashi: now the original plan was to plant one room at a time…

Holler: that’s correct. We currently forecast that the final room will be planted by the end of the first quarter 2020 and from that point onward, we will be on a continuous harvesting cycle. We’ve had a number of sophisticated growers in California come through our facility even though it’s not complete and every one of them has said to us, “This is the future of growing high quality, premium cannabis.” The proof of that will be people who want us to grow this top of the line product for them and you will see evidence of this sooner rather than later.

Ohashi: I visited the site around a year ago and went through the plan in detail. One of the things that struck me is that it is a very complex operation. Everything is automated. I mean you could almost run that place without humans.

Holler: certainly the greenhouse will probably operate with one person per 22,000 square foot bay. Eight to ten people will run the whole grow facility. The reason they can do that is on their computer monitors they get minute to minute verification of things like humidity and the nutrients the plants are receiving. That’s why I’m so convinced that once this facility is operating it will do everything the manufacturer said. Remember every system that we are using in this greenhouse is being used in a growing facility somewhere. What we have done is put them together in a way that is ideal for growing cannabis. These are all tested systems. The one thing I said when it was being planned is, “I don’t want new technology. I want technology that is proven in the industry.”

Ohashi: when the operation is up and running, you are talking about a base cost of $.50 per gram and an all in cost of just over a dollar?

Holler: that’s right. A cultivation cost of $.50 per gram and you add in state and local taxes that are $.30 a gram and amortizing the lease cost and so on. These are all real costs of operating that takes it up to $1.15 per gram.

Ohashi: and that gives you a very high grade product…

Holler: we expect to have the highest grade product in the market place.

Ohashi: does that really matter when the end result is an extract? An oil?

Holler: in California there is a large and premium market for top quality flower. There are perhaps three markets. Oil is becoming more popular with the new user many of whom are young women. They want a very discreet vaporizer that can be used very privately without any smell and so on. But the other market is what might be called the legacy user. That person still likes the smoke and the aroma. It’s all part of the experience for them. Third, it’s important to remember the medical cannabis user wants to know their medicine is being made with the highest quality inputs.

Ohashi: any final thoughts?

Holler: I’m really excited about where we sit today. Our facility will allow us to work very scientifically. We can change one thing and see what happens. If that doesn’t work, we can change something else and see what happens. My background is in the biopharmaceutical industry and that’s how we optimize production and I don’t think it’s going to be any different with cannabis. I think people are now very close to being able to see some of these things at work. When they do, everyone will appreciate that this facility raises cannabis growing to another level.

I really understand your frustration and that of investors. The one thing I can tell you is no one is more frustrated than I am. I feel that frustration every day. I truly get it. But we’re on the right track. Here’s why I am able to sleep at night. I talk to sophisticated people who come to our California facility and I complain that it’s taking twice as long and costing twice as much and they always say, “Yeah Tony but you know what? In the end, you’re doing the right thing. You’re not going to have these massive crop failures that you’re seeing in the Fraser Valley where they can’t control anything.”

When I think “Oh man, it’s a headache because of the time we’ve taken and the money we’ve spent, my consolation is I’m completely convinced that when this facility is completed it’s going to be the best grow facility in the world.”

Conclusion: In my opinion, Dr. Holler is a very credible person. As a result, I think we are on the verge of seeing some positive results out of Cathedral City. It was my choice to center this discussion on what is happening at the grow facility. But assuming we move forward as Holler says, other good things happen. We shouldn’t forget, SNNVF has provided guidance that sales from branded products should be in the range of CAN $72 to $78 million this year based on production using biomass purchased from other growers. As purchased cannabis is displaced by Sunniva produced cannabis, profit margins will improve and the bottom line will grow rapidly. Finally, let’s not forget this is California. I reported last week that Health Canada issued its 177th license and while not all of those are licenses to grow, California has a small fraction of that in terms of fully compliant growers. Sunniva has the opportunity to become one of the dominant players in a market larger than Canada. As we move ahead from here, I expect operating results will make this clear and investors will clamber in.

One year, three years, even a decade from now, are you going to be saying, “I woulda, coulda, shoulda….” or will you be one of those who punched their ticket for a ride on the SNNVF gravy train?”