Ayr Wellness Inc

Welcome to the Arrow Wellness second quarter 2024 results call. Joining us on today's call are Arrow's president and CEO, David Gobert, and the company's CFO, Brad Asher. Before we begin, we would like to remind everyone that certain comments from management during this presentation may contain forward-looking statements based on management's expectations. These forward-looking statements are provided for illustrative purposes only and are not intended to serve as and must not be relied on by you as a guarantee, assurance, prediction, or definitive statement of fact or probability. Many of these risks and uncertainties are discussed in our most recent public filings, including our most recently filed annual information form and management's discussion and analysis. Numerous risks and uncertainties could cause the actual events and results to differ materially from the estimates, beliefs, and assumptions expressed or implied in these forward-looking statements and might not be expressed today. Several of these factors that will determine AIR's future results are beyond the ability of AIR to control or predict. In light of the uncertainties inherent in any forward-looking statements, you are cautioned against relying on these statements. While AIR may elect to update these forward-looking statements at some point in the future, AIR specifically disclaims any obligation to do so. During this presentation, you may reference non-GAAP financial measures such as adjusted EBITDA and adjusted gross profit. For a reconciliation of our non-GAAP measures to GAAP results, please see our earnings release posted in the investor relations section of our website earlier this morning. I will now turn the conference over to AIR's president and CEO, David Gobert. You may begin.

Good morning, everyone, and thank you for joining our second quarter 2024 earnings call. We find ourselves in an exciting time in cannabis, and particularly here at AIR. where we continue to mature as an organization and lay the groundwork for future growth amid a dynamic political environment that offers the potential for significant steps forward. We remain confident that reclassification of cannabis from Schedule 1 to Schedule 3 will be complete before Election Day and continue to work closely with our district peers to help bring the process across the finish line ASAP. We thank President Biden for his leadership in initiating and prioritizing the rescheduling process over the past two years, and are very encouraged to see the presumptive Democratic nominee, Vice President Kamala Harris, be so vocal on this issue. At the state level, we continue to see adult use progress in three of AIR's core markets, Ohio, Florida, and Pennsylvania. Yesterday was a historical day in Ohio where AIR was among the first operators to launch adult use sales while polling on the Florida adult use referendum remains strong, and Pennsylvania continues to take steps towards passing adult use VIH legislation. We'll discuss each of these markets in detail later in this call, but the conversion of these markets to adult use provide massive opportunity for AIR, and we've made it a key priority to ensure that we're ready to capitalize on all three if and when they happen. Diving into our Q2 results. Revenues were mostly in line with the low end of our guidance and flat to Q1. However, adjusted EBITDA margins did not meet our expectations, coming in below target level. The margin underperformance stemmed from a combination of factors, including what we believe to be tightening consumer wallets that is affecting spending trends across various industries, especially among our core customer base. Wholesale price moderation within several key markets where we previously have seen strength in recent quarters. Production increases in certain markets, which are not yet optimized from a cost standpoint. And a necessary step back in Florida cultivation and production, as we made upgrades to our existing Gainesville facility, which included cultivation process and equipment changes, and the automation of flower packaging, pre-roll filling, and gummy production, which we referenced on our Q1 call and still appeared in our Q2 results. We are confident these initiatives will allow us to take two steps forward in Florida, paving the way for longer-term sustainable margin and cash flow benefits. Overall, we are confident that our step back in margin in this quarter is temporary, and that with continued operation and advancement, and as upcoming growth catalysts come to fruition, we are well positioned for margin expansion particularly as we continue to anticipate a return to growth in the second half of the year. The actions that will enable that include furthering the progress made over the last 18 months in improving operations across our markets, continuing to invest in our CPG brands, investing in selling skills and customer experience in our retail locations, and ensuring that the company is best positioned for its next phase of growth, through the expected transition to adult use in three of our core markets, Ohio, Florida, and Pennsylvania. On the upcoming adult use transition opportunities, 77 of AIR's 93 dispensaries are located in Ohio, Florida, and Pennsylvania. And as a result, AIR is more levered to these three markets than any other MSO, and we plan to be ready for this opportunity. In Ohio, Adult use sales launched yesterday across the first tranche of stores approved by the state, and we're proud to say that all three AIR-affiliated stores were included. This is a historic moment for AIR, as it marks the first time in the company's history that we've been able to participate in the first day of adult use sale in a market. I'd like to take a moment to give a huge shout out to all the members of the AIR team who worked tirelessly to ensure that we were among the best positioned to capitalize on this significant moment. In the coming months, we plan to expand further in the state and are targeting to have eight air-branded stores open by early 2025, leveraging additional licenses awarded as part of the adult use rollout in connection with our affiliated licenses. As a reminder, we have the option to acquire each store after they've been open for one year for minimal consideration. Additionally, we continue to scale utilization levels at our Parma cultivation facility and our Akron production facility to support our stores and wholesale operations. We've recently scaled out the Parma cultivation facility from six rooms at 50% capacity to eight rooms at 100% capacity to meet anticipated wholesale demand. Meanwhile, in Florida, AIR remains active in state-level reform efforts having made a considerable contribution to the Smart and Safe Florida campaign. As we get closer to the November election, we encourage everyone to support the campaign and vote yes on three if you're a Florida voter. Additionally, in Florida, the recently announced build-out of the new 100,000 square feet cultivation facility in Ocala addresses one of the company's biggest weaknesses in the state. Even with the major improvements we've made to our Gainesville facility over the years, we have still lacked premium indoor growing flower. This new facility will more than double our current flower production capacity, which supports future store openings and more full-sum menu offering that opens up to new types of customers, even within the current medical market. The planned facility, which is expected to be completed in Q2 of 2025, is fully financed with IPR. Finally, in Pennsylvania, AIR maintains a leadership role in the industry push for adult use legislation and remains optimistic about the progress made in recent months, even though adult use cannabis legislation was not included in the recent budget. In Pennsylvania, AIR maintains a robust footprint of stores and two cultivation sites that are primed to convert to adult use. If and when that moment comes, we will not need additional capex or material increase to our cost base. Diving into our operations, I will now touch upon key initiatives and progress across the business. As we look to the rest of 2024, we remain laser-focused on staying true to our business model of being a retailer of choice and a house of so-called cannabis CPG brands. All of the actions that we're discussing today ladder up to that ultimate goal. Across retail, we are focused on continuing the actions to anchor our positioning as the neighborhood store and utilizing our individual dispensaries to support their respective communities in highly localized way, training our buttenders to improve their selling skills and the overall customer experience in our stores, and increasing the number of contactable customers, bringing them into our digital ecosystem, which greatly increases the overall lifetime value. Across CPG brands, With the full re-managing of Kind and Haze now behind us, the relaunch of these brands is progressing well, with significant assets created to support our wholesale team and the in-store experience. Simultaneously, we remain highly focused on new product innovation and bringing new products to market under Kind and Haze, bringing Kind into all major form factors and increasing the overall scope of Haze premium offerings. I'd like to give our team a huge shout out for the launch of Haze live resin and live resin gummies in July, as well as the launch of our all-in-one live resin and live resin vapes, which provides a much stronger delivery system for our premium vapes offering. As we continue the relaunch of these brands, supporting wholesale sell-through will be a primary focus. We expect this will drive further growth in wholesale in Massachusetts, New Jersey, Pennsylvania, and Nevada. Our efforts are beginning to show results, with kind retail sales growing by 15% quarter over quarter and kind wholesale revenue growing 43% quarter over quarter. Last, touching on operations. Consistency, variety, and quality remain our key areas of focus. Our cultivation and production teams have undergone a massive transformation in their ways of working, simplifying standard operating procedures, providing more consistency across markets, and sharing our best practices across state lines. Improvements include the expansion of kitchens and extraction facilities, introducing 80 new strains into our cultivation facilities, resulting from our fennel hunting program, and the standardization of lights and nutrients across our facilities. These changes have allowed us to launch a significant volume of new products during the first half of the year. As the year progresses, we expect these operational changes to have further positive effects on cultivation efficiency and in giving our operating platform a more efficient cost base. I'll now turn it over to Brad to walk through the financial results before returning for closing remarks.

Brad? Thanks, David, and good morning, everyone. Q2 sales, 117.3 million, represents a decrease of less than 1% from prior quarter and an increase of just under 1% from prior year. With sales fluctuation less than 1%, sales are essentially flat relative to our guidance for the quarter, which called for revenue to range from flat to modest growth sequentially. Retail was largely flat quarter over quarter in six of our seven markets, with the exception of New Jersey being the primary driver of a 1% sequential retail decline, driven by further price compression and market competition in the state, with the market store count growing 30% during the quarter to 150, which is up roughly 80% compared to the start of the year. However, in New Jersey, we were able to maintain better than implied market share as our retail share dropped approximately 15% quarter over quarter relative to the 30% increase in store count. Overall for retail, transaction count increased 2% sequentially and 1% year over year. and basket size decreased 3% sequentially with 6% compression year over year, driven by wallet share pressure and increased competition in certain markets. The 1% retail decline was partially offset by further growth in the wholesale channel, with 4% sequential growth representing the third quarter in a row of sequential growth. From a year-over-year perspective, wholesale represents a 50% increase, driven by increases across all five wholesale markets, with the most meaningful increases in New Jersey, followed by Ohio. Q2 gross profit of 47.2 million represents a decrease of 3.5 million, or 7%, compared to prior quarter, and 9.5 million, or 17%, compared to prior year. Q2 adjusted gross margin, a non-GAAP measure of 51.8%, represents a slight decrease of approximately 120 basis points compared to the prior quarter, as a result of the aforementioned retail price compression. In addition, wholesale representing 16% of sales represents the highest ratio since Q1 of 22. Wholesale has been operating at lower gross margins given price pressure, as well as not yet seeing the full benefit from economies of scale in certain markets, with Ohio and Massachusetts still expanding utilization to about 40% and 75%, respectively, up from just 15% and 44% in last year. and there is typically at least a quarter lag for the reduced cost base to flow through within cost of goods sold. By Q3 of this year, we expect the Ohio utilization rate to reach approximately 50%, with the ability to flex into additional canopy based on market demand. In addition, in the second quarter, we began to see Florida cultivation yield improvement, complementing the success we have already seen in THC and overall quality in our Gainesville facility at the direction of our COO, George DiNardo. And we expect to see the benefit of COGS hit our margins in the second half, and we can already start to see the increase in flour volume in the state-published data, with flour market share in June representing the highest weekly average since September of 23. In Florida, we have also seen a gradual increase in the edibles category, with the launch of Kind Gummies last quarter complementing our exclusive Camino offering. As a result, gummies as a percentage of sales have roughly doubled from just 3% in Q1 to 6% in Q2, and we expect to continue to grow this segment from here. Internal branded retail sales were consistent sequentially with a slight increase of internalization of 150 basis points to 63.4% of total retail sales and 41.6% when excluding Florida. We feel this is currently at a healthy range with a potential opportunity to increase this further by a few percentage points driven by the expected ramping of Ohio adult use where we anticipate healthy levels of internalization. Loss from operations of $7.7 million represents an increased loss of $5.7 million and $3.1 million compared to the prior quarter and the prior year, respectively. Total SG&A costs represent an increase of $2.5 million and a decrease of $5.2 million compared to the prior quarter and the prior year, respectively. The increase in loss from operations was primarily driven by the gross margin pressure, as well as the increase in itemized adjustments in the adjusted EBITDA reconciliation, including startup and other expenses. which relates to the new indoor cultivation facility in Ocala, Florida, which we announced during the quarter, as well as the startup costs associated with unused cultivation capacity in our new retail stores. EDVACs were also impacted by one-time litigation settlement costs for approximately $1.4 million within SG&A. In addition to EDVACs, the balance of the SG&A increase is explained by a shift in allocations between COGS and SG&A. Q2 adjusted EBITDA of $25.7 million represents a decrease of $3.4 million and $3.7 million quarter over quarter and year over year, respectively. Adjusted EBITDA as a percentage of sales during the quarter of 21.9%, with 270 basis points below the prior quarter of 24.6%, and 330 basis points below the prior year of 25.2%. In addition to price compression, adjusted EBITDA margins were also adversely impacted by the change in the accounting for the Ohio cultivation lease. which was a result of the lease amendment this quarter, reclassifying this lease from a failed sale leaseback presented as debt on the balance sheet within construction finance liabilities to an operating lease liability. While there are no changes on a cash flow basis, the accounting will also impact the P&L presentation with approximately one million per quarter now recognized as rent expense as opposed to interest expense with the underutilized portion of the facility reflected within startup costs. The accounting change will decrease our adjusted EBITDA going forward However, notably improve our net leverage ratio. Moving to the balance sheet, we ended the quarter with a cash balance of $47.5 million, representing a $23.7 million decrease from the prior quarter, primarily driven by $21 million of interest payments, $7.2 million of non-280E income tax payments, and $10 million of scheduled principal debt payments. Year-to-date, this brings the total of scheduled principal debt payments to $16.3 million, leaving less than $7 million remaining for the second half of the year and just $17 million when looking out over the next 12 months. Year-to-date, we maintain positive operating cash flow from continuing operations of $2.7 million, which is in line with the six months ended in prior year. And while there are ebbs and flows each quarter based on timing considerations, including the semiannual interest payments for the senior notes, on a cumulative basis, we have maintained positive operating cash flow over the past nine quarters, We continue to expect approximately $20 million of total CapEx for the year, and we anticipate generating positive operating cash flow for the full year, as well as positive free cash flow for calendar 2024 when excluding the uncertain tax provision. We note that any contributions from the following three buckets are not included in our cash generation assumptions and would be considered incremental. One, the conversion of our outstanding warrants issued in February totaling up to $50 million of net proceeds. two the receipt of an anticipated erc tax credit with 10 million of 12.5 million of remaining proceeds and three the receipt of a potential tax refund from our previously amended returns with approximately 48.7 million of 50 million remaining proceeds in conclusion this is a challenging quarter from a margin standpoint however we have identified the appropriate offsets in the past through cost savings optimization and scale and i'm confident in our ability to continue to find the appropriate offsets here as well. With Ohio sales kicking off yesterday, representing the first of three significant growth opportunities embedded in our footprint alongside Florida and Pennsylvania, we have among the highest relative exposure to near-term adult youth catalysts in the industry. With that, I will turn it back to David.