Ayr Wellness Inc

Q3 2022 Earnings Conference Call

11/10/2022

spk01: Welcome to the AIR Wellness, Inc. Third Quarter 2022 Earnings Call. Joining us today are AIR CEO, Jonathan Sandelman, the company CFO, Brad Asher, and the company's Co-Chief Operating Officer, Jennifer Drake. The company will discuss forward-looking matters on this call, including targets for revenues and adjusted EBITDA. This forward-looking information is subject to the assumptions and risks as described. in the company's management discussion and analysis for the quarter ended September 30th, 2022. As well, we remind you that adjusted EBITDA is a non-GAAP measure. We refer you to the reconciliation to GAAP measures and other disclosure concerning non-GAAP measures contained in AIRS management discussion and analysis for the quarter ended September 30th, 2022. I will now turn the call over to AIR's CEO, Jonathan Sandelman. You may begin.
spk06: Good morning, everyone, and thank you for joining our Q3 2022 conference call. It's been a busy quarter in the cannabis industry and the broader macro environment. So I'd like to start off today with a few comments on industry dynamics and the bigger macro picture. On one hand, rising interest rates and the threat of a recession are maintaining pressure on the consumer wallet, and supply and demand dynamics continue to impact wholesale cannabis prices. On the other hand, despite this backdrop, cannabis continues to behave like a consumer staple that we know it to be, evidenced by the strong unit volumes across our markets. In Washington, the federal government has shown its strongest appetite yet for cannabis reform. The executive branch has ordered an expeditious review of the scheduling of cannabis, and safe banking appears to have its strongest ever chance of passing. While these would be welcome catalysts for the industry, at AIR we remain focused on optimizing our assets, regardless of what is happening around us. We're encouraged by the progress that we've made in this regard. In Florida, the results of our efforts are showing. We're delivering on what we've been working towards for the last 20 months. As AIR continues to build market share with its revamped product offerings and a higher quality flower and premium genetics, we are proud that the introduction of the AIR's brands and cultivation and production practices in Florida has resulted in the highest ever market share. Over 9% in flour and over 12% in oil in the month of October. That's more than doubling our market share since AIR assumed control of the business. We now anticipate initiating the transition to the AIR retail brand in the first quarter of 23. And we'll be proud to have the AIR name on our Florida stores. In New Jersey, a few months into our adult use sales, our stores are producing and picking up momentum. And we only introduced our flour in the adult use market in late October. We anticipate converting our Garden State dispensary stores to the Air brand this quarter. In areas like wholesale and our Boston dispensaries, we know that we still have work to do. Our wholesale team continues to make progress in the people and process elements of the business. This is an area where continued improvements can and will lead to more opportunity, regardless of the broader market dynamics. Our new dispensary location in Boston has ramped more slowly than we'd like to see, and we are implementing an improvement plan to swiftly address this. As we look ahead to 2023, we expect further growth to come from closing on our dispensary 33 acquisitions in Illinois, adding adult use sales to our Somerville, Massachusetts dispensary, beginning sales from our state-of-the-art cultivation facility in Ohio, 15-plus new stores opening in Florida, and the continued phase opening of our Massachusetts cultivation expansions. We expect these catalysts to begin to contribute in early 2023. For the fourth quarter 2022, we anticipate solid continuous sequential growth from our existing assets. Before getting to the financial results, I want to briefly touch upon the important milestone for our company, the hiring of our president, David Goubert, who we believe is a key addition to our team as we work to optimize our assets. David joins us from Neiman Marcus Group, where he served as President and Chief Customer Officer, responsible for the full P&L of the Neiman Marcus brand. Before that, he spent 20 years at LVMH, including 15 years in supply chain and retail stores at the flagship Louis Vuitton brand, and five years running all retail in its Starboard Cruise Line division. We are incredibly excited to have him on board, not only due to his resume and business acumen, but his track record as a leader of people. I'll now turn the call over to David to further introduce himself and outline his short-term focus.
spk11: Thank you, John. I'm incredibly excited for the opportunity to join AIR at such a pivotal phase in the company's journey. AIR has built an incredible foundation over the past three years, and now my job is to help optimize and scale the business. As John outlined, my background has spanned operations, supply chain, manufacturing and production, customer experience, retail, and marketing. And I look forward to learning the intricacies of cannabis and how to best apply each of these experiences to this unique industry. I love leading people and building strong cultures. And I believe cannabis provides an excellent opportunity to do that with a team that is passionate about the potential of cannabis and deeply invested in the social good elements that it brings. It is my personal goal to visit nearly all our facilities in the first three months of my tenure at AIR. I'm looking forward to meeting the teams, to being immersed in the world of cannabis and applying what we believe are highly relevant, adjacent skill sets to the unique industry that this is. I look forward to speaking with you all in the future and providing updates on our progress. I'll now pass the call over to our CFO, Brad Asher, to walk us through our third quarter financial results.
spk07: Thanks, David, and couldn't be more excited to have you on board. Jumping into the quarterly results, Q3 sales, 119.6 million, represents an increase of 23.5 million, or 24% year over year, and an increase of 9.5 million, or 9% quarter over quarter, tracking closely to our guidance of approximately 10% sequential growth. Retail sales increased 11% sequentially, primarily driven by the launch of adult use sales in New Jersey and Massachusetts, a full quarter of contribution from our two Illinois stores, and continuous improvement in our Florida stores. The increase in retail sales was offset by a 4% decrease in wholesale revenue, driven by further price compression and shifting more of our products through our retail channel. As a result, retail sales from internal product increased by approximately 7.2 million sequentially, increasing to 56% of our total retail sales. This shift, along with further improvements on yields and productivity, allowed us to expand adjusted gross margins by 60 basis points sequentially to 52.6%, our highest of the year. As our cultivation and production expansions continue to come online and further ramp, and our national brand portfolio continues to roll out across our footprint and gain market share, we anticipate internal branded retail sales will continue to increase. Florida is the best example of realizing economies of scale in cultivation and production. with our improvements in these areas driving an approximate 50% reduction in cost per pound, while simultaneously improving quality, evidenced by our highest-ever flower market share within that state. This is just one example. Of our four large-scale new cultivation facilities in Arizona, Massachusetts, Ohio, and New Jersey, only the Arizona facility contributed fully to third-quarter results. Q3 adjusted EBITDA of 21.7 million represents a decrease of 17% year-over-year and an increase of 10% quarter-over-quarter. Loss from operations totaled 20.7 million and represents a 17% improvement from the prior period. Both metrics are in line with our guidance of 10% sequential growth. The sequential increase in adjusted EBITDA was driven by the increase in sales and adjusted gross profit and with a further decrease in SG&A expenses as a percentage of sales, driving a sequential improvement on the loss from operations. When excluding non-cash expenses, such as depreciation, amortization, and the gain loss on sale of assets, total operating expenses decreased by 300 basis points sequentially as a percentage of sales, which on a dollars basis represents an increase of $1.2 million relative to the $9.5 million increase in sales for the quarter. We anticipate this metric to consistently improve with our sales growth expected to outpace SG&A in the fourth quarter and further into 23. Assuming the current economic and market dynamics, we anticipate adjusted EBITDA margins expanding to approximately 25% by mid-23, as we continue to gain leverage from ramping sales along with increased verticality across our strategic footprint. Moving to the balance sheet, we ended the quarter with a cash balance of $100.7 million, which was a decrease of 14% from the prior quarter. The decrease was driven by remaining CapEx payments, along with further investment to build inventory in new markets, each accounting for approximately $8 million, respectively. CapEx spend during the quarter represents a 70% reduction from the average pace in the first half of the year. Overall, operating cash flow was modestly positive for the quarter, marking a significant improvement to the first half of the year. We expect further improvement in this category over the coming quarters, though next quarter will be impacted by the timing of semi-annual interest payments, which are due by year-end. We anticipate positive operating cash flow in 2023, in addition to minimal uses of cash for both CapEx and M&A during the year. We anticipate CapEx in 2023 will represent less than $30 million, significantly less than the prior two years, and is fully funded with $100.7 million of cash on hand. And this is without considering the opportunity to further monetize our real estate portfolio, which we have done successfully over the first half of the year with industry-leading mortgage rates. In closing, we believe we are well-positioned to benefit from the multitude of potential industry catalysts, both at the federal and state level. However, we are focused on achieving success based on the current market conditions, including the current volatility in the capital markets and the impact 280E has has on cash flow. To that end, we will continue to focus on maximizing our cash positions and liquidity profile as a top company-wide priority. I'll now pass the call over to Jennifer Drake, our COO.
spk05: Thanks, Brad. We all know challenges exist both in the macroeconomic landscape and within the cannabis industry. While this is the world we live in today, it's important to remember that our business is fundamentally well positioned to weather difficult circumstances. Cannabis is not a discretionary item that customers turn away from when their budget is squeezed. It is an extremely important wellness foundation for many of our customers. But now is the time to remain agile as a business, quickly identifying the most important issues, then acting decisively to implement our plan of action. In Florida, We applied this mindset when we identified early that cultivation and production limitations were holding back the potential of our retail footprint in the state. We implemented a plan to improve our store menus, focusing on cultivating quality flour efficiently at scale, adding capabilities to produce additional form factors, and introducing our CPG brand portfolio throughout our retail footprint. The menu improvements that resulted from these changes have made our stores a destination for Florida cannabis consumers. Lost in Translation, Road Tripper, Haze, Entourage, and Kind are all driving strong volume at healthy margins, helped by air's low cost of production. And the variety in form factor and price points we've established in our stores is allowing us to attract a wider cross-section of cannabis consumers. With product quality and availability we can be proud of, we've begun the process of rebranding our stores from Liberty Health Sciences to AIR, which we expect to kick off in late Q1. As John mentioned, we have the volume of product and menu variety to support opening 15 plus new stores by next summer. In New Jersey, we had a similar issue with our menu and product availability at the start of our adult use sales in June. A limited menu was holding back our customer experience, and we're currently in the midst of implementing a very similar playbook to what we just outlined for Florida. Our retail operations are starting off from a much stronger base in New Jersey, but we have additional room to ramp as we continue to expand our menu with more high-quality internal product offerings. We are just now beginning to bring our brand portfolio into the New Jersey market. having only introduced our own adult-use flour in October. The menu improvements since bringing our Air brand portfolio to New Jersey have led to an uptick in traffic and stronger margins. And with the customer experience on track, like in Florida, we can now convert New Jersey's Garden State dispensary brand to the Air retail brand in the coming months. It is still early days for our New Jersey retail business, and we anticipate further growth in the coming quarters. To accommodate that growth at retail, we're increasing parking and POS stations across our stores. Florida and New Jersey both provide excellent examples where we identified issues, acted decisively to address them, and are now capturing further growth from our assets as a result. We are in process now of acting decisively to address issues we've identified in Boston retail, and our national wholesale business, key areas where we know we can improve. In greater Boston, our new retail locations have not ramped as quickly as we'd like. Our store locations are excellent, but these are brand-new locations, not existing medical stores adding recreational sales. We can do more to build local brand awareness, and we're now kicking off a large campaign for this with ambitious goals to boost customer traffic by the end of the year. In wholesale, we've identified needed people and process updates and have focused on infusing our team with new talent and developing stronger internal systems to support them. We believe there's significant opportunity in our wholesale business once our optimizations have time to take hold, backed by our investments in customer service, product quality and variety, and support for our well-crafted CPG brand portfolio that offers quality across price points. Looking ahead, as John mentioned in his opening remarks, we anticipate solid Q4 2022 results that continue the sequential growth trends we established in Q3. And we expect that solid sequential growth to expand further in 2023. As interest rates rise and there is an increased potential for recession, we are mindful of the increased investor focus on balance sheets and cash flow generation for cannabis companies, including AIR. We have a very enviable footprint and asset mix to support our balance sheet while we grow into the earnings power of our business that we've outlined for the last few quarters. We have a strong liquidity position today with over $100 million of cash on our books, and we are taking advantage of the ample time we have in front of our key maturities in 2024 to optimize our balance sheet. The most important factor in the strength of our balance sheet is the continued optimization of the assets we've just invested in. 2023 will be the first year where our CapEx cycle is essentially complete and our infrastructure and most of our state-by-state footprint will be operational for the full year. And at the same time, our earnings and cash flow are ramping. I'll now turn the call back to John for his closing remarks. Thank you, Jen.
spk06: While we find ourselves in an uncertain time in our world, it remains an exciting time for cannabis. On Tuesday, voters in Maryland and Missouri proved that cannabis reform continues to be a priority, and it's only a matter of time until we see more concrete action from the federal government. AIR remains ready to adapt and has laid much of the groundwork to uplift to a major exchange when that day comes. In the meantime, AIR has many exciting developments to monitor, including the optimization of our existing assets and the upcoming catalyst that I discussed earlier that will unlock further revenue, profitability, and scale for our organization. As always, thank you for your support and to our teammates for their invaluable contributions. We'll now take your questions.
spk01: Thank you. We will now begin the analyst question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. Analysts are asked to limit themselves to one question and then return to the queue if they would like to ask more. To withdraw your question, please press star, then two. We will pause for a moment as callers join the queue. Our first question comes from Kendrick Tyke of ATB Capital Markets. Please go ahead.
spk08: Thank you, and good morning. In the prepared remarks, you called out the high-quality flower and premium genetics in Florida. You also highlighted the improvement in market share and the menu changes that you made in that market. Could you speak to and provide some insight on how that has also impacted your average basket and how the more premium flour quality has impacted your pricing power, both in absolute terms and also relative to your key competitors in that market? Thank you.
spk05: Kenwick, thanks so much for the question. In terms of Florida, we really are incredibly pleased with the menu traction that we've had over the last several months. And it really has been a sea change over the last several months for us. So we're very, very pleased with that and very happy to have that as our first question. So thanks. In terms of the impact on our particular baskets and the SKU mix that we have in our stores, We really, for the first time over the last few months, have been participating more in the high quality eighth segment of the market. And the more that we sell in that segment of the market, the more we're going to have larger basket sizes in Florida. Now that being said, I will also say that introducing our Road Tripper brand, which is known as Later Days in Florida because it's a very medicinal market, but it's the same branding. introducing a road trooper brand in Florida has been also an incredible success and really entirely taken over, I would say, the more value segment of our flower offering within Florida. People love the quality they're getting. They love the everyday low pricing that we introduced over the summer. I think we've seen some other folks in the market follow suit with that, so it sort of indicates I guess imitation is the greatest form of flattery. But it's something that we've done throughout our footprint. We started it in Nevada where we were famous for being the home of the $49 quarter. And that approach to customers has been really powerful. So I would say we're actually doing great on both ends of the barbell in terms of the high-quality flower and also really wonderful reception for a road tripper.
spk07: Brad? Yeah, I would just add that in late September, early October, we launched our premium brands, including Lit and Haze. And so while we saw a little bit of a decrease in basket size in Q3, we expect those premium brands to settle out in terms of the sales mix in Q4 and for that ticket to rebound in Q4 as well.
spk01: Our next question comes from Matt Bottomley of Canaccord Genuity. Please go ahead.
spk02: Good morning, all. Thanks for taking the questions here. Just wanted to go back to the balance sheet to appreciate some of the color on some of the cash budgeting for next year on the CapEx, coming in a lot less than historical levels. Is there any other sort of buckets you're able to provide, whether it's working capital, a very inquisitive name relative to a lot of your peers? So I'm wondering if any of these potential contingent payments on M&A potentially come due in 2023, you know, interest coverage, anything that just gives a greater picture of sort of the potential cash needs going into next year?
spk05: Hey, thanks so much for the question. So talking about the balance sheet, as we said, we feel very strongly about our near-term liquidity with over $100 million on the balance sheet. And we've looked to try to be – very transparent with the external market when it comes to our capitalization. If you go to the capital, if you go to the capital capitalization slide from our deck, which I think is slide 18 in the newest deck, we try to give a decent amount of forward expectation with respect to that. It goes through contingent consideration. It breaks that out by consideration type, stock, cash, debt, et cetera. And what you'll see there is there's virtually no forward cash considerations, very, very low as a percentage of our contingent consideration. But happy to discuss it. It's kind of a technical item and very happy to discuss it offline.
spk01: Our next question comes from Matt McGinley of Needham. Please go ahead.
spk10: Thank you. You noted that you expect EBITDA and operating income to grow 10% quarter to quarter, but you didn't mention top line other than to note the macro pressures and price compression. Why would you have better visibility into EBITDA growth compared to revenue? And I guess, would you expect EBITDA margins to be up or down in the fourth quarter relative to the expectations that you noted before? you'll be in the, I guess, mid-20s by the middle of next year.
spk05: Thanks for the question, Matt. I would say we expect Q4 to look a lot like Q3 in terms of the sequential growth, and that's really what we were looking to indicate to the market. And I think we feel most strongly about, you know, our – growth we will see at the EBITDA line because we think we're going to get some SG&A leverage there as well. But what we really wanted to signal to people was that we expect Q4 to look a lot like Q3, which is strong, solid sequential growth quarter over quarter. Brad, what would you add?
spk07: Yeah, in terms of not guiding on top line, it's more so on the internalization trends that we're seeing and our shift of product to our stores. So whether it's sold wholesale or in retail, it's the same contribution on a gross profit-dollars basis, and so we felt more comfortable guiding to profitability.
spk01: Our next question comes from Andrew Semple of Echelon Capital Markets. Please go ahead.
spk03: Thanks for the results. I just want to ask on and go back to the Florida market. And I mean, we can all see the volume data there. It's clearly indicating that there's been a significant improvement in dried flower volumes within the states. Yeah, I guess, you know, I'm just wondering how we should be thinking about this into Q4 in 2023 on a gross margin basis. You know, should we expect gross margins to improve in that state as you better utilize existing infrastructure and as you bring down your cost per pound? Or is the company at this stage more focused on patient acquisition and, you know, running the business more along that strategy and so margins should remain, you know, relatively consistent in that state? How should we be thinking about that?
spk05: Hi, Andrew. Thanks so much for the question. I would say we're focused on both customer acquisition and continuing to optimize our production, continue to bring costs down to the extent that we can, the continuous improvement focus that we have across our footprint, and I would say almost especially in our Florida cultivation and production facility because over the last 20 months, we've been just uniquely focused on that in the Florida grow-make part of our business. So it's very strong muscle memory to be continuously improving in our Florida cultivation facilities. That said, we are absolutely, to your point, starting to get really great gross margins out of our Florida business, and we will continue as we open these 15-plus new stores to be acquiring new customers. So I would say the answer to that is both and.
spk01: Our next question comes from Scott Fortune of Roth Capital Partners. Please go ahead.
spk04: Good morning, and thank you for the question. I appreciate the color on the menu stuff because you're rolling out a lot of new products across new markets, but just help us understand the priorities there, initiatives in context with the challenge consumer in this market. With the premium and the value segment, what are you seeing that's sticking with the consumer on the new products. And then just a quick update on New Jersey. When do you expect to kind of fully optimize the New Jersey market as far as sales ramping in stores and the production side with those approved categories? That'd be great. Thanks.
spk05: Sure. I think you snuck two in there, Scott, but we like you, so 100% we'll answer both. So in terms of the menu, what... As you know, 50-plus percent of our SKUs are flour. So as we introduce our new branding into markets, it's really important to us to get flour right. And what we've seen in Florida is a great example is as we've introduced these premium, unique, differentiated genetics in brands like LITS, people are reacting extremely well to those, even though they are at the higher part of the price and value spectrum. People love Road Tripper. They just love it. It's a great brand. It does incredibly well. So what we're seeing is those compelling brands, because of the branding, because of the quality that's inside, Inside that branding, the quality of the product, we're seeing people react well on both ends of the spectrum. Road Tripper probably has a bit of a head start given the value nature of the consumer right now, but we are seeing really good traction when we introduce it into a market. When we did that with Florida, we saw it made up a huge portion of our SKU sales as we introduced it in the first few days, same with Massachusetts. So we've seen really good results on both sides. Switching to New Jersey briefly, as I mentioned, we got some of our own products in in September. We got our own flour into the stores in October. So again, 50% plus of the SKUs being flour. Super important to get our own flour into the stores. So you'll see that we anticipate seeing New Jersey continue to improve and optimize through the fourth quarter and probably into the first quarter as well.
spk01: Our next question comes from John DeCourcy of BTIG. Please go ahead.
spk09: Hey, guys. Congrats on the quarter. Just wanted to touch on, you know, I don't think you ever quantified how much of a drag Hurricane Ian closures were on Q3 results, and then kind of piggybacking on that, were there any meaningful precautionary closures for either yesterday or today from the latest hurricane? I'm drawing a blank on the name of it, but for today's storm?
spk05: Hi, John, thanks for the question. First of all, welcome to BTIG. I think this is your first call as our BTIG analyst, so... I hope you're settling in well there. In terms of the Florida impacts of the hurricanes for us, we consider ourselves fortunate in that Ian did not have a particularly material impact on our business. It was probably 500K of lost revenue, we think, for the third quarter. And our cultivation and production facilities were essentially unharmed, and more importantly and most importantly, all of our people were safe and accounted for. So we consider ourselves very lucky and very fortunate because certainly the state of Florida, where we're sitting right now, has had a tough time, particularly with Hurricane Ian. With Nicole, we've had, I would say it's been less impactful, materially less impactful than he is. So again, not something that's going to make a big dent.
spk01: Our next question comes from Andrew Bond of Jefferies. Please go ahead.
spk00: Hi, good morning. Andrew Bond on the line for Owen Bennett. Thank you for taking our question. I wanted to revisit your comments around macro headwinds on the consumer. Could you expand on the dialogue, like which markets you are seeing the largest macro headwinds or impacts from this? And are there any states where you've seen this be less of an impact? And can you comment on how your smaller scale relative to larger MSOs might impact your strategy as you navigate through these pressures? Thank you.
spk05: Sure. Thank you so much for the question. In terms of the macro headwinds, I would say we've probably seen the biggest impact on areas where our consumer skews lower income. And in particular for our footprint, that's going to mean Nevada. I think everyone has seen the market share data or market data for Nevada. Depending on the month, the size of that market is generally down roughly a third. relative to this time last year. And that's a meaningful decrease. What I would say for us, and I think this is a point of pride for AIR, is that our Nevada business, while it's down a little bit, it's gained market share and it is incredibly strong. We continue to gain share and generate strong revenues and cash flow from our Nevada business, despite the fact that that is an incredibly tough market. And very much the playbook that we've taken to places that are competitive like Florida comes out of our really strong success in Nevada. At this point, Florida is a larger contributor to our revenue than Nevada. So we have 52 now stores in Florida. And we have six stores in Nevada. So that just goes to show the fact that I mentioned them in the same breath and indicate that Florida just passed Nevada, that shows you how strong Nevada is for us. So when I said earlier that it's important for us to remember that this business is fundamentally well-positioned for these difficult environments, it comes from... our strong experience being in tough markets like Nevada and knowing that the consumer uses this product as a foundation for wellness.
spk01: Our next question comes from Matt Bottomley of Canaccord Genuity. Please go ahead.
spk02: Thanks, Al. Just a follow-up for me, just speaking more on sort of some of the market share gains that you guys had at the retail level. I think you noted six out of seven markets thought sequentially higher. Just given your historical sort of premium strategy, if that's a word, on a lot of the products that you've put out there, obviously you've had some share gains in Florida, as you mentioned. What's your philosophy looking forward in this inflationary environment? If the dynamics stay the same, do you think you'll need to shift more down to sort of what they call the value segment, which I know isn't as profitable? How do you balance sort of trying to build a premium brand versus where the market is right now in terms of what consumers are willing to spend?
spk05: Sure. Thank you for that follow-up, Matt. When we think about our product offerings and the brand portfolio that we've put together, we've put together our brand portfolio very consciously to have across form factors and across price points the best quality at each price point across the form factor. So that doesn't mean that we're only premium. That doesn't mean we only sell lit and kind. We also sell Road Tripper. Road Tripper is a value brand. It happens to be my personal favorite brand. I love the branding and everyone who talks to me about it knows that I love it. But we have consciously established our brand portfolio so our customer can move up and down the price spectrum and get the best value for money at that price point by staying within our brand family. So in times like today, road tripper is probably going to be more popular with our customers than it would be if their wallet was flush with cash. But in two years or a year, whenever we see inflation come down, the economy pick up, and people have a little bit more money in their pocket and they want to go, they want to splurge on a great new lit strain, they can stay within our family and do that. So we've been very conscious about putting together a brand portfolio that can weather different market conditions and still resonate with our customer.
spk01: This concludes the question and answer session. as well as today's air wellness conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
Disclaimer

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