Cresco Labs Inc. (CL) Earnings Call Transcript & Summary

Good day, and welcome to Cresco Labs First Quarter 2023 Earnings Conference Call. [Operator Instructions] . I would now like to turn the call over to Megan Kulik, Investor Relations for Cresco Labs. Please go ahead.

Thank you. Good morning, and welcome to Cresco Labs First Quarter 2023 Conference Call. On the call today, we have Chief Executive Officer, Charles Bachtell, Chief Financial Officer, Dennis Olis; and Chief Transformation Officer, Greg Butler, who will be available for the Q&A. Prior to this call, we issued our first quarter earnings press release, which has been filed on SEDAR and is available on our Investor Relations website. These preliminary results for the first quarter of 2023 are provided prior to completion of all internal and external reviews and therefore, are subject to adjustments until the filing of the company's quarterly financial statements. We plan to file our corresponding financial statements and MD&A for the quarter ended March 31, 2023, on SEDAR and EDGAR later this week. Certain statements made on today's call may contain forward-looking information within the meaning of the applicable Canadian securities legislation as well as within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. These forward-looking statements may include estimates, projections, goals, forecasts or assumptions that are based on current expectations and not representative of historical facts or information. Such forward-looking statements represent the company's beliefs regarding future events, plans or objectives, which are inherently uncertain and subject to a number of risks and uncertainties that may cause the company's actual results or performance to differ materially from such forward-looking statements, including economic conditions and changes to applicable regulations. Additional information regarding the material factors and assumptions forming the basis of our forward-looking statements and risk factors can be found in our earnings press release and in Cresco Labs filing on SEDAR and with the Securities and Exchange Commission. Cresco Labs does not undertake any duty to publicly announce the result of any revision to any of its forward-looking statements or to update or supplement any information provided on today's call. Please note that all financial information on today's call is presented in U.S. dollars, and all interim financial information is unaudited. In addition, during today's conference call, Cresco Labs will refer to certain non-GAAP financial measures such as adjusted EBITDA, adjusted gross profit and adjusted gross margin, which do not have any standardized meanings prescribed by GAAP. Please refer to our earnings press release for the calculation of these measures and reconciliation to the most directly comparable measures calculated and presented in accordance with GAAP. These non-GAAP financial measures should not be considered superior to as a substitute for or as an alternative to and should only be considered in conjunction with the GAAP financial measures presented in our financial statements. With that, I'll turn it over to Charlie.

Good morning, everyone. Thank you for joining us on the call today. On our call in March, we highlighted our priorities for 2023 as we execute against our 3-year plan. This is the year of the core and the year of cash. We're leaning into our core, investing wisely and rationalizing and optimizing everything we do to generate profitable revenue expansion, drive healthy margins, create more cash and strengthen our balance sheet. On today's call, -- we'll focus on the steps we're taking across our business to execute against this strategy. We're pleased with our Q1 results. Cresco's team generated $194 million of sales. Our revenue performance was solid across our footprint with some softening in Illinois that caused the sequential decline in revenue as well as much of the margin pressure. Dennis will provide more detail on that. But overall, across our footprint, we performed well in wholesale, help fair share in retail and drove increased productivity across every facet of the business. In today's environment, we are hyper focused on what we can control, stabilizing for today and optimizing for the future. Our relentless prioritization of providing the highest perceived value to the consumer is paying off and continues to give us the #1 selling portfolio of branded cannabis products in the entire industry and an incredibly productive retail platform. Our products reach the shelves of 1,600 dispensaries across our 10-state wholesale footprint, and we rang up almost 1.2 million orders at our Sunnyside dispensaries. Now I'll review how we're executing on our strategy using the 3 pillars of our 3-year strategic plan, ensuring we have the most strategic footprint broadening our wholesale brand leadership and driving retail productivity across a larger base. Number one, we're ensuring we have the most strategic geographic footprint. Over the years, we've designed our footprint to ensure we have access to the states with appropriate regulations and large consumer populations to execute against the thesis that cannabis is one of the largest consumer product goods of the future. As industry and state programs evolve, it's important that we stay nimble and adaptable to maximize our opportunities and minimize our risk across the footprint. That's the active component of creating and managing the most strategic footprint and the impetus behind the rationalization and optimization efforts you've seen from us in recent quarters and can expect from us going forward. We are continuously evaluating and tweaking our practices to make incremental improvements at every touch point in the cultivation, manufacturing and retail process to address the nuances that develops as states mature. Our core markets are strong with scaled operations that create significant profit and cash flow from operations. We're operating more efficiently, improving productivity in our supply chain and adding more automation in our facilities. We're leaning into these markets to drive more growth and market share while bolstering enterprise profitability. Looking across our footprint, we're also preparing for significant growth catalysts in states like Pennsylvania, Ohio, Florida and New York, as those markets convert to adult use. We continue investing wisely in those markets to improve our productivity, expand our product offering and strategically open new doors. BDSA estimates these 4 states alone will double in size over the next 3 years as adult-use programs come online, and we will be ready. At the same time, we're deemphasizing markets that don't have a pathway to scale and profitable growth. On our last call, we talked about our decision to close underutilized and unprofitable facilities in California and Arizona, 2 of our lowest margin states. We recently completed the wind down process for these facilities. So those actions, along with many other changes we're making across our organization to optimize and rightsize our business will materially improve our margins starting at the end of Q2. Number two, we maintained our position as the #1 branded product portfolio in cannabis. Consumers continue to love our brands and products. According to BDSA, we continue to be the #1 selling portfolio of branded-cannabis products in the entire industry. With our prioritization of providing the highest perceived value to the consumer, we produced the #1 portfolio of branded flower, #1 portfolio of branded concentrates, #4 portfolio of branded vapes and #4 portfolio of branded edibles. And in our strong core markets of Illinois, Pennsylvania and Massachusetts, we continue to hold the #1 overall share position, and we're happy to say we now have a top 5 market position in the very competitive Michigan market. We continue to drive growth in our brand portfolio through smart investments in new form factors and winning brand extensions. For example, in Massachusetts, we launched the popular Good News Vapes, which grew our market-leading share in the state. In Pennsylvania, we launched strokes, addressing a specific form factor gap in the market. We're extending our successful edibles brand with the launch of Chews in Florida, which already account for 10% of Sunnyside sales in the state. And we're also introducing more flavors and effects such as good news Vegas, which boasts elevated effects with caffeine. Along with brand extensions, we're taking steps to combat pricing pressure by premiumizing our portfolio and delighting shoppers at higher price points. We launched new FloraCal products in Illinois, Florida, Michigan and Massachusetts, which complement our value brand, high supply. Enthusiasts are happy to pay more for ultra-premium FloraCal flower solventless concentrates and Live resin edibles because the value proposition of quality and price is appropriate. This high loan strategy is helping us address more targeted consumer audiences and purchase occasions, driving higher baskets and ultimately gain more market share growth across our existing footprint. Finally, we're making small investments in simple and efficient innovations that can be launched quickly with fast paybacks. We're looking at proven segments such as pre-rolls and medicinals which we already have the expertise and capabilities, but we've historically under-indexed. And number three, we're also doubling down on our highly productive retail in the most strategic states. Our investments in retail are paying off. Despite new competitive doors opening, we continue to take more than our fair share in key markets because of our targeting loyalty marketing and customer service. Even with new stores entering competitive markets like Illinois, we were able to outcompete and hold our absolute retail share. In Q1, Sunnyside.shop, our proprietary e-commerce platform reached a significant milestone, registering $1 billion in sales since its launch in 2020. This is a testament to our focus on creating the best customer experience in cannabis, both online and in our stores. Currently, over 70% of our transactions originate via Sunnyside.shop, which gives us incredible insight into our customers' buying behaviors while also creating more opportunities for basket building and highly effective targeted promotional strategies. Our newly launched loyalty program is another success story. It's providing us with more valuable data and while also giving us the opportunity to celebrate and reward our most loyal customers. In Q1, we signed up 100,000 customers, bringing the total to over 160,000 since it was launched at the end of last year. Engaged shoppers on our platform spend 12% more than the average shopper, expanding these platforms will help us continue to drive more from our existing shopper base. While it wasn't in Q1, I do want to commend our team for the phenomenal job they did on [ 420 ] which set a record for single day trips, units sold and retail sales, up 14% from last year's holiday. We're pleased with the progress we've made so far in reducing our retail operating expenses to improve margins in an environment where pricing is under pressure, but volumes continue to grow. In fact, we're handling customer transactions more efficiently than ever. During the quarter, we sold nearly 3.2 million units at retail, up 7% year-over-year and processed nearly 1.2 million transactions, up 3.5% year-over-year, all with 10% fewer retail employees. Reflecting on the quarter, it's clear we're taking the necessary steps across the entire organization to improve margins and create a materially stronger company. We've rationalized and exited margin-dilutive operations in California and Arizona, while also investing wisely in cultivation, innovation and brand building. We leaned into our robust retail infrastructure to defend and expand our share against new competition even in the toughest markets. Cresco Labs is built for this uniquely challenging environment because we understand what we do best. We know what levers to pull. This is what we mean by focusing on our core and you can expect to see more of this targeted prioritization as we charge ahead. Before I pass the call over to Dennis to review the financials, I want to give a quick update on what's happening in D.C. and with our pending Columbia Care transaction. While the industry was disappointed in the lack of movement on the Safe Banking Act and other federal reforms last year, it established the foundation for the progress we're seeing so far in 2023. I was in D.C. earlier this month and attended the Senate Banking Committee hearing on the Safe Act. I cannot overstate the significance of this event. SAFE has passed the house 7 times. This is the first time that SAFE has been the focus of the Senate hearing. While SAFE isn't everything we need as an industry, the tiering is an incredibly important part of progressing toward reform. It's important to remember that this is merely a moment in time on the journey of the cannabis industry. and we will continue to show up at that table as a trusted operator and stakeholder to push these discussions forward with federal legislators. With regard to Columbia Care, we continue to collaborate closely with Columbia Care on the divestiture transactions required to obtain the regulatory approvals, which are conditions of closing. While we do not have an update to provide on the timing related to the outstanding divestiture transactions, we continue to work with Columbia Care to find a path forward that makes both strategic and financial sense. We must come out of any transaction a stronger company than we would be as a stand-alone company. With that, I'll now turn it over to Dennis to review our financial results.

Thank you, Charlie, and good morning, everyone. I'll be reviewing the financial results from the quarter, then highlighting a few items from the balance sheet and discussing our capital position. As Charlie said, we are pleased with the results in the first quarter. We are navigating industry-wide pressures and taking steps across our organization to prioritize P&L strength and cash flow. In the quarter, we generated $194 million in revenue, a 3% decline quarter-over-quarter. This decline was driven almost entirely by Illinois, where the total market was down 5.6% as Missouri launched its adult-use program putting significant pressure on border stores resulting in lower overall revenue. The impact of Missouri and new store openings in close proximity to established stores resulted in more competition for both retailers and wholesalers in the state. Importantly, net of Illinois, we saw growth across the rest of our footprint. The dynamics in Illinois resulted in our retail operations being down 3% quarter-over-quarter and wholesale revenue being down 2% over the same period. Overall, when we look at BDSA market share stats, we continue to perform incredibly well in branded market share which accounts for all our branded products sold on our shelves and third-party retailers, a great proxy for how consumers are voting with their dollars on brand and product quality and how Cresco is competing in its markets. We also held market share in every state where share data is available. Looking ahead to Q2, we expect total revenue to be flat compared to Q1 as our growth in retail sales attributed to new store openings in Florida and Pennsylvania is offset by new competitor store openings, narrow dispensaries in Illinois, Pennsylvania and Ohio, price compression and the impact of our most recent rationalization actions in California. Throughout the rest of the year, we will see some impact to revenue as we exit low-margin businesses and furtherance of our continued efforts to improve overall margins and cash flow. We expect modest market share gains for our branded portfolio as we execute on expanding our winning brands in new states, premiumizing our portfolio and expanding in segments where we are under-indexed today. Overall, adjusted gross profit in the quarter increased 120 basis points sequentially to 46%. Improvements in efficiencies across the platform were negatively impacted by the revenue mix by state. The sequential revenue decline in our high-margin state of Illinois was offset by higher revenue in lower margin states like Massachusetts, California and Michigan, which resulted in a margin drag of approximately 270 basis points. We are taking steps to bring margins up in sequential quarters as we strive for improved cash flow and continue to rationalize margin-dilutive operations. As Charlie mentioned in his opening comments, last month, we reduced our footprint in California and entered into an agreement with KSS to distribute our products. This decision was in further in our plan to reduce our fixed costs in markets where our overall margin is dilutive to the company. This change in California was effective as of mid-May and will begin to reflect the full cost benefits of this in Q3. Similarly, margin expansion from the improvements we've been making in automation, cultivation processes across many of our states and expense reductions in other areas of the business will be recognized in the coming quarters as we sell through our higher cost capitalized inventory. It should be noted that our current period tax reflects the cost of products manufactured in previous quarters, so the benefits derived from recent cost actions will take a quarter or 2 before they're recognized our P&L. Total adjusted SG&A declined slightly from Q4, inclusive of the openings of 8 dispensaries in the quarter. These new stores accounted for $3 million in additional SG&A expense in the quarter. We've taken additional actions in Q1 and Q2 to streamline our operations, reduce cost in cultivation and production facilities and reduce our overall functional expenses at corporate. These additional steps, along with further significant cost actions planned, will yield additional savings over the remainder of 2023 and 2024 when we expect to see the full benefits of these changes. Adjusted EBITDA totaled $29 million, flat sequentially. Adjusted EBITDA margin of 15% was up modestly, but below our long-range target, primarily due to lower revenue in the high-margin stated in Illinois. Looking ahead, we expect adjusted EBITDA margin to improve as the measures we took in Q1 and those planned in Q2 begin to flow through the P&L, improving both gross margins and SG&A. We continue to focus on improving our working capital management. We held inventory flat for the fourth consecutive quarter, even with a purposeful buildup of inventory to support 420. We paid approximately $34 million in taxes in the quarter, making us current on our federal tax obligations through 2021 and state taxes through Q1 of 2023. Our remaining 2022 federal tax liability is approximately $50 million for which we filed an extension in April of this year. Even with the large Q1 tax payment, we generated positive operating cash flow of $3 million in the quarter. As noted with adjusted EBITDA, we expect to see improvements in both operating and free cash flow, especially in the back half of the year as the steps we're taking today to reduced costs are fully recognized. In Q1, we spent $21 million on CapEx primarily from the addition of new stores in Florida and the development of our upstate New York facility, which is required to maintain regulatory compliance in the state. Q1 was the heaviest quarter of the year for investment, and we will see a dramatic reduction in our need for CapEx for the balance of the year. We ended the quarter with $90 million of cash on the balance sheet, and we feel good about our cash position. Free cash flow improvement is our #1 goal for 2023. The improvements we are making to our operations continued cost management and significantly lower CapEx will improve our cost structure and margin profile, beginning in Q2 and more so in the second half of the year, building to our goal of 50% gross margin and 20-plus percent EBITDA margin by the end of the year and set us up for a strong 2024. With that, I'll pass it back to Charlie for some closing comments.

Thanks, Dennis. We're seeing a lot of potential in optimism in my head. This industry is finally getting the attention to deserves from legislators, a federal bill being heard in the Senate and following what's referred to as regular order. We talked in tuck passed medical cannabis law, and we're seeing more adult-use markets come online and radicate of cannabis continues to grow. We're working to improve every aspect of our business to take advantage of this positive momentum. We're managing through the environment today to improve profitability while at the same time, optimizing the company for the industry of tomorrow. The long-term cannabis growth story remains unchanged. Cannabis is still position to be one of the largest consumer products categories in the U.S. And Cresco Labs is doing what needs to be done to secure long-lasting industry leadership. We are holding share in our largest highest margin markets while deemphasizing those markets that negatively impact margins. We're reducing our corporate overhead and driving operating efficiencies throughout our entire organization to offset pricing pressures. We're investing in projects and innovation where we see the opportunity for short-term cash returns. We're focusing on generating more free cash flow through better inventory and cash management to strengthen our balance sheet, and we're continuing to lead the efforts on federal reform, which is the most important path towards unlocking the true potential and value in the cannabis industry. With that, I'll open the call for questions.

[Operator Instructions] Our first question today is from the line of Aaron Grey of Alliance Global Partners.

So first question, I have its been enclosed to on in terms of the updates for divestures for Columbia Care. But just probably given your comments in terms of the path forward and you talked about both strategic and financial stance. I think we understand the strategy. Just want to get more interest how you thinking about the financial stance. As you look for a pass forward in the central proforma debt and how that plays a role in to carry have some near term and long term that kind of -- not that it's free cash positive today, but both you are working towards that. So can you offer som color in terms of pro forma structure would make that financial sense for you and potential paths towards that either additional divestitures de-restructuring? I think that would be very helpful.

When it comes to the commentary on strategic and financial sense, the way to look at it really, there's a couple things that are the several things are within our control and the several things are outside of our control as relates to the transaction. And of course, the divestitures and the resulting proceeds from those are a big component of, as we said from the very beginning, our ability to get the combined debt leverage ratio of Cominco in the right spot. So as the divestitures remain open. And before we're able to complete those, that's a big driver of whether or not the deal can proceed with a structure that allows us to achieve the goal that we set out at the beginning. So it really does come back to -- as these divestitures still remain be closed, they're a big driver of whether or not we can make the deal makes sense, and we'll continue to update the public as we have more definitive information on the divestitures.

Okay. Great. Second question for me is just in terms of the gross margins. You talked about way down some about California, and I think you mentioned the market within about 200 basis points. Last quarter, the way down by some inventory and net realizable value adjustments as well. So I just want to clarify, were there inventory adjustments again that weighed on it this quarter? Or were there new things that kind of weighed on the margins? I think last quarter, excluding those not occurring that would've been about 5%. So I just wanted to get some further commentary in terms of what weighed on margins last quarter versus this quarter? And then how to think about that gross margin going forward?

Aaron, this is Dennis. Let me answer the question. There were no additional inventory charges in Q1. The impact of the gross margin is really been a reflection of the fact that the state mix accounted from about 270 basis points in the quarter. So we did see a drop in Illinois revenue associated with the adult use move to in Missouri, which had an impact with wholesale business down near the border state, so that had an impact. And then if you look at where -- and that's get one of our highest margin states. So the fact that we lost some revenue in high margin say, pick up some revenue in states like Michigan, California and other states with lower margins. That makes a contort about 270 basis points in the quarter. California had a minimal impact in the quarter relative to sequential change from Q4 to Q1. We do expect to see some significant improvements in margins as the actions that we took in California and Arizona in Q4 and Q1 will go through the P&L in Q2 and subsume quarters.

Our next question is from the line of Andrew Partheniou of Stifel GMP -- my apologies as question with Andrew. But our next question is from the line of Scott Fortune, of ROTH MKM.

Now that you've done the actions in Arizona and California, and that's been taken, can you provide the kind of timing of the SG&A and improving the margin profile? I know you had mentioned before that late second quarter here, but we should really see the margin improvement come from the second half of 2023 to kind of update on the FDA improvement as we look going forward.

Thanks, Scott. So again, when we -- the actions that we take -- that we took in California and Arizona, we capitalized the cost as we incurred them in the period and then we expect them to the P&L as those products shipped. So the actions that we took in Q1 will start to have some impact in Q2 as those products that we built in Q1 ship into the market in Q2 and Q3. So we will see some benefit our margin in Q2 as a result of that, but more so we'll see the full impact of those actions in the second half of the year. So those combined actions will account for about 150 basis point improvement from Q1 into the second half of the year.

Got it. I appreciate the color. And then real quick, I know you mentioned Q1, your heaviest CapEx from the standpoint but just kind of set us through kind of the new store adds. I know you're targeting Florida and Pennsylvania coming onboard kind of your midyear, can you provide this update on new store adds as you half 2023? And any other capacity expansions on the board with this CapEx from that company?

Yes, I think I want to get. So the $21 million of CapEx that we incurred in Q1, $14 million of that was associated with store openings, the bulk of that being in Florida as we had 8 stores that opened in the quarter. The -- had a couple of million dollars in Pennsylvania as well for new store openings that we opened in Q1. We'll have -- take a couple more that will open in Q2. The bulk of the CapEx expenditure that was from a facility standpoint was in New York. We continue to build out our facility in New York to be compliant with the state regulations. We expect to complete that buildout in late Q3, early Q4. So that did account for about $7 million or $8 million of CapEx expenditures in Q1. We are looking at some financing alternatives to offset some of the investments that we made in facility today.

Any color for new store adds kind of come forward to take?

So I'll take that as just for this quarter coming up, we'll have one new store on our line in the coming quarter.

And you will see a severe slowdown in store opening half year.

Our next question is your line of Andrew Partheniou of Stifel.

Sorry about earlier. I just wanted to first ask on the Columbia transaction. I was just wanted to -- and kind of the way that you are looking at things. If we can look at all possible scenarios here and just assume that the Columbia Care transaction doesn't close. I'm wondering if you can give a little bit of color on how you're thinking about growth catalysts. Illinois stores are opening even if slowly, and they do have a long runway to go here. You also discussed growth this quarter in every market outside of Illinois. So wondering is the thinking maybe to manage your cost controllables until Illinois growth comes back in a meaningful way? Or would you consider going back out in the M&A market and maybe acquire a smaller operator or a single-state operator in an attractive state.

Yes. Andrew, thanks for the question. This is Charlie. I'll start it off. You laid out some of the components that would be a part of the go-forward strategy as a stand-alone company for sure. If you look at Illinois, there's still -- there's a doubling of total addressable market here in Ilinois that should come in the next 2 to 3 years. As those new stores open, again, with our market share and our position here, we anticipate being able to capture a good percentage of future growth that's still left in the Illinois market, so excited there. If you look at the best of the footprint, you've got adult use catalyst still head of us in Pennsylvania. -- appreciative of Senator of on the street that was filed about the bipartisan bill that should be for coming there. So optimistic about that catalyst ahead of us in PA, again, where we have great market presence and share. Adult use catalyst expected in Ohio, adult use catalysts expected in Florida, New York actually launching and a viable adult-use program. and share gains in other markets that we're in that we still have room to grow. So there's plenty of growth left in the existing footprint. And then cannabis is one of the most dynamic industries in the country for a variety of reasons, and we'll continue to be very diligent in cost management during this period of time where we're still sort of in this regulatory and banking limbo, but also continue to be observant and see if there are opportunities for us to make smart positive profitability revenue-type opportunities that are out in the marketplace. Greg, additional color?

A couple of things. As Charlie mentioned, as we think of our gross in the core plan, we see opportunities. Additionally, as Charlie mentioned is taking some of our existing products that are showing success in markets like Illinois, expanding those across their footprint. In the quarter, we talked about we were pleased with good news performance in new states, FloraCal continue to ramp out in new states, which gives us only a unique proposition, but also a premium price point. That's one thing you'll see for us is because of the fact of the year. The second is store growth. And that's not only just new stores opening up in states like Illinois, but even stores where we have 100% distribution -- 100% penetration, we don't have 100% distribution on our core us. And so getting those retail doors that we already have a relationship with buying across our platform gives us an opportunity for new growth. And then year end, there's a couple of categories, and I think Dennis mentioned this too, as we drive efficiencies in operations, we're improving our yield per square foot in our biomass availability and our labor availability, which means that we can start to produce SKU that we have like joint in all category joint is a very large segment in cannabis is an area we have in play, but we can now as we increase biosimility and labor and also smaller, but categories like medical. So all of those give us incremental growth opportunities on the wholesale side within that gives us future growth. And then in retail, for us, it's a new sight in the results continuing to both up-sell and cross-sell our shoppers in the categories that they may not be buying and driving up frequency of their trips as well.

Appreciate that color. And maybe another one, just on -- I realize you're not prepared for -- or you're not providing any updates on timing of the divestitures. But maybe you can talk a little bit about the process to extend the outside date. It seems last time around, you announced an extension mutually agreed, of course, about one month before the outside date. I'm wondering how we should think about that here. If you can maybe talk about the steps or approvals necessary to obtain an extension so we can kind of follow that progress.

Sure, this is Charlie. So I think whether we extend or not is a board-level discussion and decision, and that will be mainly driven by progress that we see on the divestiture front in the weeks ahead. So I don't have much more to offer than that. It's an active situation. As we make more progress and get more information as it relates to the divestors that will inform the decision on the extension process and timing.