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spk09: Ladies and gentlemen, thank you for standing by. Welcome to the Cannabis Company third quarter 2023 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would like now to turn the conference over to your speaker today, Asia Gilbert, Director of Investor Relations. Please go ahead.
spk01: Thank you, Operator. Good morning, and thank you for joining the Cannabis Company's third quarter 2023 Earnings Conference Call. With me today is Chief Executive Officer Nicholas Vita, President and Chief Operating Officer David Hart, Chief Financial Officer Derek Watson, Chief Commercial Officer Jesse Shannon, and Senior Vice President of Capital Markets and Investor Relations Leanne Evans. Earlier this morning, we issued a press release reporting our third quarter 2023 results. A copy of this release is available on the investor section of our corporate website, where you will also be able to access a replay of this call for up to 30 days. Certain remarks we make today regarding future expectations, plans, and prospects for the company constitute forward-looking statements within the meaning of applicable Canadian and U.S. securities laws. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, which we disclose in more detail in the risk factor section of our annual Form 10-K for the year ended December 31st, 2022, which has been filed with applicable regulatory authorities and also in subsequent securities filings. Any forward-looking statements represent our views as of today and should not be relied upon as representing our views as of any subsequent date. While we may update any such forward-looking statements in the future, we specifically disclaim any obligation to do so, except as otherwise required by applicable law. Also, please note that on today's call, we will refer to certain non-GAAP financial measures such as EBITDA and adjusted EBITDA. These measures do not have any standardized meaning prescribed by GAAP and may not be comparable to similar measures presented by other companies. The cannabis company considers certain non-GAAP measures to be meaningful indicators of the performance of its business in addition to, but not as a substitute for, our GAAP results. A reconciliation of such non-GAAP financial measures to their nearest comparable GAAP measure is included in our press release issued earlier today. With that, I will turn the call over to Nicholas Vita to get us started. Nick?
spk10: Thank you, Asia, and good morning, everyone.
spk12: Thank you for joining our call today. For those of you who have been following the cannabis company over the past several quarters, we have highlighted a number of initiatives to optimize our geographic footprint, innovate and enhance the breadth and depth of our product portfolio, drive operational efficiencies, and to proactively manage our balance sheet to prioritize cash flow generation and reduce net debt. all the while navigating economic, industry, and regulatory headwinds. As you know, during the third quarter, we announced the termination of our merger agreement. Our freedom to operate was constrained for 16 months, resulting in a backlog of corporate actions that we are now free to pursue. The four categories below will enable us to drive shareholder value and execute upon our long-term strategy to remain one of the leading companies that defines the industry. The first tenet of this program was proactive balance sheet management. We announced and continue to implement our balance sheet improvement plan. This includes an announced share offering with one of our largest institutional investors to eliminate $25 million in debt and substantially reduce the overhang caused by the May 2024 debt maturity. The reduction of interest expenses material at approximately $3.3 million annually. The proposed debt for equity exchange that would reduce debt by an additional $25 million in our 2025 maturity potentially decreasing interest expense by another $1.5 million annually if approved by the OSC. We continue to work with our institutional debt holders in a constructive way to announce additional measures to push out maturities beyond 2026, reduce interest expense, and decrease net debt. To increase liquidity, reduce net debt, and focus our resources on our scaled markets, we continue also to make progress to selling non-core assets, including the sales over Missouri and Utah operations. To accelerate inventory monetization, reduce working capital needs, and drive cash flows subsequent to the announcement of the transaction termination, we began reviewing inventory priorities to better reflect our standalone strategy and continue to restructure our cultivation and manufacturing assets to accommodate our needs, all of which resulted in a number of transaction-related adjustments to gross profit in the quarter. This work will continue to a lesser degree in the fourth quarter, but we'll position the company for sustained improvement in gross margin in 2024. Second tenet of our planned activities involve income statement optimization. We have completed the final phase of our previously announced corporate restructuring in third quarter and finalized headcount reductions to reach targeted SG&A expense levels and reset the company's EBITDA margin at a higher sustained level. We are conducting a review of our D&A policies, which, in addition to the balance sheet changes I described a moment ago, will positively impact our cost of goods sold, contributing to a sustained gross margin improvement in 2024. Specifically, the restructuring and cultivation and manufacturing assets that we mentioned in prior quarters will largely be completed by the end of 2023, enabling us to reset normal course activities after having operated in a corporate sale environment for over a year. Off the heels of our focus on improving cost of goods sold, we launched our dedicated wholesale effort in September to develop institutional trading relationships across the country, accelerate utilization of dormant cultivation capacity and high growth and adult use of conversion markets, such as New Jersey, Maryland, New York, Ohio, Virginia, and Pennsylvania. A decision that will shift our revenue contribution towards wholesale going forward. This will be a higher EBITDA margin initiative and enable us to recapture a portion of the absorption accounting penalty we've discussed in past quarters. Finally, as the national rollout of our new branded manufactured goods continues, although this process began late in the quarter, we have already seen a positive margin impact in demand profile, which will enable us to utilize excess cultivation and manufacturing capacity. In addition to our ongoing negotiations to restructure our portfolio of sale leasebacks, which will impact both gross margin and adjusted EBITDA, as well as cash flow, furthermore, it will enable us to retain greater asset value and reduce our cost of debt. As we discussed, our efforts to continue deleveraging will reduce interest expense, insulate the business from market volatility, and improve cash flow. Although we continue to make tax payments, we also look for ways to manage our 280E tax burden more efficiently, particularly in the context of rescheduling. Last but not least, we intend to leverage our geographic footprint and expand our retail network to drive scale, utilize our manufacturing capacity, and enhance our wholesale positioning with a priority on limited license markets. For example, in Ohio, we are already citing three additional dispensaries that are expected to come online with adult use conversion, allowing us to activate dormant cultivation and manufacturing capacity in anticipation of that market expansion in 2024. In New Jersey, with a significant regulatory hurdle now behind us, we believe that we are moving towards the completion of our third dispensary location, anticipated opening in 1H24, which is located in a high-density population area with few competitors. In Maryland, the expansion of our Montgomery County location will enable us to leverage our presence in that market more effectively, while in addition, opening a new dispensary in Prince George's County is expected to be equally attractive based on the limited number of competitors and the size of the local marketplace. In Virginia, we expect to open two more dispensaries that have already been cited in one first half of 2024, affirming our leadership position in one of the country's most attractive markets. Finally, everybody's favorite, New York. Our adult use application has been submitted. We are preparing to co-locate facilities and, in turn, activate dormant manufacturing capacity in anticipation of a 4Q23 approval for wholesale and retail sales. We continue to look for two additional dispensary locations to round out our portfolio. The third tenet is cash flow prioritization, which will be driven by the following initiatives. Steady-state CapEx for the past several quarters you've seen will continue with limited capital spend going forward based on our prior period investments. Our focus on gross profit, operating profit, portfolio rationalization, SG&A optimization, and improved tax strategies will be leveraged by our anticipated reduction in interest expense. Finally, our initiatives to stabilize our capital markets dynamic The first step, we consolidated our trading activity this quarter onto CBO Canada, which is a senior exchange that will enable us to enhance regulatory oversight, increase market transparency, and eliminate risks associated with venture exchanges. We've been working to rebuild our relationships with investors, lenders, and other financial counterparties that have atrophied candidly over the past 16 months during the proposed merger. And then this morning, we announced a share repurchase program to allow the company to equity, which we believe is one of the best ways to deliver shareholder value and generate a return on investment for our capital. Finally, we transitioned away from Columbia Care and announced our conversion to the Cannabis Company. We believe this will improve our retail consumer awareness, raise employee excitement, better align our name with our mission and market dynamics, and finally, we believe that the Cannabis Company will support our outreach efforts to better connect with retail investors and recapture the institutional momentum that will come with rescheduling. Although we didn't have a full quarter as a standalone company, as you can see, we've taken advantage of every minute. It has been an interesting period for our organization and leadership team. We've taken the right steps to position the cannabis company for a very successful 24 with a clear pathway to show you all how we can leverage our best-in-class operations and generate the margin profile to prove it. In doing so, our intent is to deliver shareholder value over the next several years in a way that we haven't done so in the past, which leads us to our third quarter performance. Despite clear pricing pressure, we were able to deliver a stable top line in Q3, achieving approximately $130 million in revenue. Similarly, through aggressive cost management and resource allocation, we also showed a slight improvement to our adjusted EBITDA margin in dollar terms and margin with over $20 million for the second consecutive quarter. This was accomplished in spite of gross margin pressures. As you will hear about from my colleagues momentarily, pricing pressure in several markets impacted the average basket size at the retail level by nearly 7% across the portfolio. This was offset by a 6.8% sequential increase in transaction, led by a doubling in Maryland, which saw over 100% increase quarter over quarter, and a 1.5% improvement in revenue per square foot in our locations that have been open less than 12 months. Although our dedicated wholesale effort did not begin in earnest until late in the quarter, the team was able to increase our wholesale revenue contribution sequentially by 3% by leveraging our strong brands, taking an enterprise approach with trading programs, with trading partners, and formalizing a national wholesale team, as Jesse will highlight. We are just getting started with our revamped wholesale strategy and are very, very excited about what the future holds for us. As importantly, we are making substantive progress in managing our liquidity, strengthening our reducing interest expense, and methodically marching towards positive cash flow from operations, which we achieved in a quarter, one quarter ahead of our guidance. In a moment, Derek will provide a more detailed overview on these topics. Lastly, before I turn the call over to my colleagues, I would like to spend a moment discussing the regulatory environment. We have one of the best footprints in an $80 billion emerging market. As clearly demonstrated by the electorate of the state of Ohio last week, and in New York last week by accepting and moving forward with the expansion of its adult use market. Whether it's a red state or a blue state, there is a continued groundswell of support across our country for the legalization of cannabis. The passage of Issue 2 in Ohio sets in motion the transition to adult use. While regulators and legislators move at the speed of government, we look forward to welcoming all Ohioans in the future. five retail locations with additional locations expected. As a reminder, Ohio is a top five market in terms of revenue and adjusted EBITDA for us, and as David will discuss, opportunities remain to further expand our network in that state. Notably, Ohio is the 24th state to legalize recreational use of cannabis, and more than half of the U.S. population now lives in a jurisdiction where the possession and use of cannabis is legal. And as I mentioned a few minutes ago, our company is one of the best positioned geographically to capitalize on the continuation of this trend. We saw it in New Jersey. We saw it in Maryland. Ohio is in motion, as are Delaware, Virginia, Pennsylvania, and New York. In addition to progress at the state level, we are also on the precipice of historic federal rescheduling of cannabis, which will reshape the financial profile of the industry once enacted. While there are no guarantees in Washington, we are as confident as ever that we will see positive news in 2024. As I've said before, our best days are ahead of us. Let me close my thoughts with where I began. The cannabis company maintains a strategic geographic footprint of retail locations and fully built out cultivation capacity across the country. Our operations are improving as we institutionalize a number of changes across the portfolio. growing our brands, and improving our capital structure in a massive growing industry. We are proud to stand as the cannabis company, and we look forward to keeping you apprised of our progress as we achieve positive cash flow, profitability, and drive shareholder value over the coming quarters. Now with that, let me turn the call over to Derek.
spk13: Thank you, Nick, and good morning, everyone. I'll provide a summary of the financial results for the third quarter, discuss key trends in our markets, and comment on the continuing initiatives to strengthen our balance sheet. For the third quarter, we achieved 129.2 million in revenue, flat compared to the second quarter, and down 2.6% from the prior year. Adjusted gross profit was 50.3 million, a decrease of 3.6% sequentially from Q2. Adjusted gross margin of 39% was down slightly from Q2, and we continue to see an approximately five percentage point impact of absorption accounting from underutilized facilities. Adjusted EBITDA was $20.5 million, up 1% sequentially over Q2 and down 2% year-over-year. Our adjusted EBITDA margin was 15.9%, a slight improvement over Q2 and also up over the same period in 2022. As we move into details supporting our results, it should be noted that we had a little over eight weeks of standalone operations in the quarter after breaking from the CRESCO merger agreements. Not surprisingly, the quarter therefore had a number of transactions reflecting our unwinding from that situation and relaunch as a standalone company. During the third quarter, we opened one additional cannabis retail location in Suffolk, Virginia, bringing our store count to 86 as of today. We anticipate new store openings in 2024, but none through the balance of this calendar year. In Q3, retail revenue decreased less than 1% sequentially, driven by a marked decline in average basket size in a number of our markets, despite continued growth in transaction volume. Part of this was anticipated as we reduced pricing on certain products in key markets to help clear through inventory. Wholesale revenue grew more than 3% sequentially as compared to the second quarter, as we began executing on our new wholesale initiative. As we've highlighted previously, due to the rationalization of certain cultivation assets and temporarily taking canopy offline, our gross margin remains impacted by unfavorable absorption at underutilized sites, requiring us to expense overhead costs rather than capitalizing them into inventory. In Q3, this once again reduced our gross margin by approximately 5 percentage points. We view increasing utilization at our cultivation sites as an opportunity to recapture gross margin in 2024. The third quarter was also impacted by a number of one-time charges related to the terminated merger agreement. These were primarily inventory write-downs, and for accounting purposes, the reversal of assets previously treated as held for sale during the transaction period. At the end of July, we announced some incremental cost reductions, primarily from completing integration of the GLEAF acquisition. Together with previously announced initiatives to close or reduce cultivation operations, close unprofitable retail stores, and eliminate corporate positions, we're on track to generate a net $38 million in annual operating savings. Onto our liquidity. We ended the third quarter with $60 million in cash on hand, excluding restricted cash balances, as we completed a $25 million equity offering in September. Capital expenditures were $2.5 million in the quarter, supporting the store opening and certain manufacturing upgrades. Cash flow from operations in the quarter was $1.8 million, consistent with our stated target of generating positive operating cash flow by Q4 of this year. Our next senior debt maturity is in December when $5.6 million of convertible notes become due, and which we intend to settle out of available cash. In October, we used the proceeds from our recent equity offering to redeem the majority of our most expensive debt instrument, 13% senior notes due May 2024. This early redemption alone provides $3.3 million in annualized interest savings, with now $13.2 million of this senior debt obligation remaining. As previously noted, we've taken additional measures to strengthen our balance sheets including two new mortgages that closed in early August, grossing us $8 million and used to pay off other seller notes. We've also announced today the signing of a definitive agreement to divest our Utah assets for $6.6 million in gross proceeds. We continue to target initiatives to delever the balance sheet, reduce interest expense through the remainder of this year, and into 2024. With that, let me turn the call over to David Hart to share our operational achievements and ongoing growth opportunities. David?
spk11: Thank you, Derek. I will now highlight some of our operational results and developments for the third quarter. On a revenue basis, our top five markets alphabetically were Colorado, Maryland, New Jersey, Ohio, and Virginia. Maryland replaced California in Q3 as adult use sales began at the start of the quarter. On an adjusted EBITDA basis, our top five markets were Maryland, New Jersey, Ohio, Pennsylvania, and Virginia. unchanged from Q2. I want to point out that New Jersey and Virginia remain top markets, which continues to demonstrate the strength of our emerging markets. Maryland had its first full quarter of adult use sales, and we were pleased with the results we saw with a 55% increase in revenue. Our product portfolio has improved, and we're committed to continuing to meet the growing consumer demand in that market as adult use takes hold. Wholesale revenue in Maryland increased 30% over Q2. During the quarter, we increased the diversity of our product offerings, planted new genetics, introduced a number of new SKUs, and continued to optimize our cultivation efficiencies. We did see a decline in average basket size in Maryland, consistent with transitions to adult use. That was offset by the doubling of transaction volumes. We have one additional retail location development, which we anticipate opening in 2024, which will bring us to the state cap of four retail locations. Operations in New Jersey continue to perform well as we capitalize on the growing market and innovative products that we bring to the market. The new form factor is launched in Q3. We planted and harvested new strains, and we are seeing high-testing quality flower out of our two facilities. With additional retail stores opening in the market, we saw a 35% increase in wholesale sequentially and remain focused on generating opportunities for additional wholesale partnerships. Our two cannabis locations are in the state remain among the top performers in our national portfolio. Our third New Jersey retail location is in development and expected to open in 2024. On to Ohio. We have seen a significant increase in average potency in terpenes in the plants coming out of our facilities. Overall garden health is improving, and we are seeing success with branded products via our retail and wholesale channels. We did see pricing softness in the quarter, a function of targeting more competitive pricing as well as a reduction in inventory. Ohio continues to represent a wholesale growth opportunity for us as additional dispensaries come online, and we look forward to the market's transition to adult use in the future as we anticipate adding three retail locations to the five already operating in our portfolio. In Pennsylvania, our cultivation team focused on providing the market with a wider variety of extracts and higher testing flower strains that can command higher price points. We generated a 3% increase in wholesale revenue during the quarter and are steadily moving inventory through our retail doors. During the quarter, we continued to leverage different pricing strategies as we saw a decline in wholesale pricing in the market. Virginia continues to be a top market where we saw single-digit top-line growth sequentially as we opened our 10th location in the state during the quarter. Operationally, we are streamlining our cultivation efforts in our two cultivation facilities. Our flower is consistently testing well, and the team continues to plant fresh genetics. We are in the process of developing two additional retail locations in 2024 to reach our market-leading maximum of 12 in the state. I want to thank the team for their continued commitment to quality and innovation. We are improving our operational efficiency every day, and our improved operating procedures and strong team will propel both our wholesale and retail businesses going forward. I'm excited about our position in the market and our continued focus on operational execution. I will now turn the call over to Jesse. Jesse?
spk08: Thanks, David. It was a busy quarter for the company. As you saw in September, we announced a corporate rebrand and launched a cannabis company, which I want to discuss in more detail. This wasn't just a facelift for the company branding. This was about reconnecting to our passion and what drives us, which is our customers, reengaging with our brands and partners, continuing to remove the stigma that still surrounds the cannabis industry, and showing a sense of pride for being part of this evolving industry during a pivotal time. A lot of thought went into the preparation and execution of this corporate rebrand. We wanted to ensure that all aspects of who we are, our name, the experience we provide our customers, The commitment that we have to our history and the industry are all aligned with where we feel we are headed as a company. We wanted to approach our new identity in a way that recognized our past and celebrated our future. We knew we had a name in retail that not only worked, but also developed excellent customer loyalty and positive reviews. We also knew that we wanted to continue to leverage our current strengths and our ultimate mission to deliver a higher experience. Our goal is to provide a platform from which our team can deliver a welcoming, approachable experience that meets the customer wherever they are in their cannabis journey. It was clear that our future is the cannabis. This rebrand was not only for our customers, brands, and partners. After a long period of uncertainty for employees, we truly wanted to reconnect with our team and show them that we are as proud to lead a cannabis company as they are to work for a cannabis company. We wanted to show them that we are connected to something that is inclusive and positive. We are connected by cannabis. Since our last update, we've made progress towards reaching our goals of transforming the way we approach building brands and redefining the consumer experience. We've developed a national centralized new product development process for each region to better execute and track product and brand launches, and our hard work is paying off. We introduced a number of our brands to markets across the portfolio and increased the number of SKUs we offer. During the quarter, we expanded our offering of CDStrain in Virginia, launched numerous SKUs, including a 1-gram hybrid vape, 1-gram sativa pre-rolls, 3.5-gram hybrid flower. We also launched 28-gram indica flower, marking the first time the cannabis company has sold full ounces in the Virginia market. We also launched 20 new SKUs in Massachusetts, including several strains of high-testing flower, a variety of topicals, and heady fast-acting gummies in six flavors, also including heady chocolate bars. Our amber concentrate has continued to perform well as we bring that product to additional markets, We expanded the brand into Colorado and California, where it received great reviews. In California, Amber Clear won five awards at the Farmer's Cup, including first place in overall solvent carts, category, and best-looking cart. Amber also took home first place at the Earl Cup in Arizona. Now for a few honorable mentions for the quarter. We expanded the partnership with the Buttercake brand in Delaware, now offering a peach elixir and PD&J brownies. We launched our premium 777 flower in Colorado and is now available at all of our retail locations in the state. And finally, in Florida, we received approval to launch several of our brands in Q4-23, including Heady, Feed & Strain, and Classics. We look forward to bringing our award-winning brands to customers in Florida and look forward to updating you on their performance on future earnings calls. You've also heard us mention the newly established national wholesale team. While we saw modest growth in wholesale revenue in Q3, we're just getting started. A dedicated team is ensuring that our branded products are available in increasingly more retail locations throughout the country. beyond just our stellar footprint of 86 locations. As we increase our wholesale program, we expect to see increased capacity utilization in our cultivation facilities, as well as our upgraded manufacturing capabilities. In that vein, we have some exciting new partnerships in development, which we will be announcing in the coming months. We've come a long way in the past few months and have continued to implement changes that will make us a better company. We remain committed to listening to our customers and delivering the best products and experiences to suit their needs. The future is bright for the cannabis company, And we're grateful to have you all here to witness our evolution. With that, I'll turn the call back over to Nick to take your questions.
spk12: Nick. Thank you. Operator, can we open up the call for questions?
spk09: Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. The first question comes from Aaron Gray with Alliance Global. Your line is open.
spk02: Hi, good morning, and thank you for the questions. You know, first one for me, I just want to talk a little bit about, you know, adult use conversion, you know, talking about Maryland specifically. Up nicely, you know, in the quarter sequentially. You know, it looks like it might have you know, lag the market overall. So kind of, you know, a high level of view in terms of these market conversions. I know you have a new store coming online. But speaking to, you know, Maryland and maybe some of your learnings, you know, from New Jersey, we also have, you know, a new store coming there with a newer adult use market. Can you speak to some of the learnings you've had from adult use conversions? You know, what you think you did well, what you might have wanted to do better to kind of capture more of the initial market share, especially when you have these higher average sale prices at the early days? and maybe how you might look to execute an upcoming adult use conversions in markets such as Ohio, and then potential markets such as Florida, Pennsylvania, and Virginia that could convert as well. Thank you.
spk11: Sure. This is David. I'll take that. I think we've been through a few of these adult use conversions, and I think we've tried to take lessons from each one of them. As it relates to Maryland, I think one of the things we're trying to improve on is consistent with what we've seen in New Jersey is literally just getting the capacity and the throughput potential for the people that want to come through our doors. So limiting lines, optimizing peak times with staffing and technology continues to be a focus for us. I think there's The introduction of any adult use market brings new competition. I think dynamic pricing in the marketplace is highly relevant for adult use converting markets. So being able to be reactive at the hyperlocal level, both on the downside to make sure you're keeping market share, but also when you know you've got products that are turning that are in high demand to optimize your price points. So for me, from a retail perspective, it's certainly about optimizing our footprint and staffing and technology to get people through the door and to make sure that we don't have a drop in our customer journey from a quality perspective. So that's a balancing act at times when we open the floodgates, if you will, for adult use volumes that come in. But I think each time we've entered an adult use conversion, we've done better than the previous ones. The caveat always is each market looks a little bit different, but those are the types of things we try to get ahead of and plan for Some markets it's easier to do when you're coming out of a medical program into an adult use program from a physical location and setup perspective. And so we're trying to think about that proactively in markets like Virginia and markets like Ohio and certainly New York. So from a throughput transaction capture perspective right out of the gate, it really comes down to technology, labor, and optimization of the pricing on the menu.
spk12: I mean, Aaron, the only thing I would add to that is Every state has its own story. In Maryland, we don't have that much more capacity in Montgomery County, so we have to find a new location. PG County has been notoriously difficult to find a spot. We've been looking for a couple of years now. We think we've finally found two alternatives that we're in the process of negotiating. And turning those around and actually opening the door ought not to be that difficult because we've done it so many times. But that's on the one hand. In New Jersey, we've been looking at this one area for the better part of a year. We had a problem with the New Jersey Department of Transportation, believe it or not. The rest of the state and infrastructure locally was supportive of us moving forward with a particular location. And it's hard to handicap what happens when you have somebody at the DOT in New Jersey who decides to interpret a regulation one way and it doesn't make any sense to anyone else. But that's, you know, that's something we would have loved to have avoided, but it's the pitfalls of dealing with local, state, and municipal governments all on a single issue. You know, I think on the flip side that you could look at Virginia, where we have built out our infrastructure, where we are prepared for conversion, and where we are the market leader. You know, we recognize that that's an opportunity for us to really take advantage of a very sizable marketplace that's coming online. And I would say New York is the same way. We're probably the most scaled operator in New York right now. We have all of our facilities open. Some of our competitors can't even apply because they don't have their dispensaries open yet. So that may have been a prudent decision up until this point, but now that New York has accepted our application and, you know, we expect them to move fairly quickly. I'm sure you saw the headline this morning out of New York. It's the second largest cannabis market in the United States. I mean, it's prolifically affected by the illicit market. But I think our value proposition is better than something that could possibly be laced with fentanyl. And I think that the state will be very supportive of that once the applications are reviewed and accepted. So, you know, I... I think we shoot for perfection. We're clearly making strides in New Jersey and Maryland. We've been a beneficiary of it. But we also, for every New Jersey, we have a Massachusetts, right? And so we need to see stabilization across the portfolio in order to see real sort of forward progress. And I think that we just happen to have more catalysts over the next 12 months than I think a lot of folks do because we're ready in New York. We're ready in Virginia. We're ready in Pennsylvania. We're ready in a number of states. that are coming along in Delaware. And I think that, you know, unlike some others, we actually have more sort of organic, sort of, let's call it untapped option value embedded in New Jersey because we don't have our third location open. I think in Maryland, you know, Peachy County and a better location in Montgomery County are going to be enormously valuable because it's still a limited licensed state. So, you know, it's a fair question, but I think that the way we've tried to address it is as best we can. in the context of all the local dynamics that we have to, we have to deal with.
spk02: Okay. All right. Great. Thanks for that color there. And then on speaking to Virginia, right. It's an important market for you. Um, and it seems like there might've been some prospects, uh, you know, for Adobe to kind of turn back on what was the Democrats taking in the house last week. So given the song, the regulatory bill that we we've had, um, in the house was under Republican control. Do you think the prospects improve? Are you more bullish on. something being passed? Or do you believe, you know, the Republican governor who seemingly against, you know, those canvas remains a major hurdle given potential veto there? Thank you.
spk12: You know, it's hard. It's hard to tell whether or not Youngkin would veto something at the end of the day. I think that he has his own platform that he's looking at. And I think that the, you know, the, there were some changes in some pretty important leadership positions on both sides of legislature. But, you know, we're, you know, it's kind of heads we win, tails we win, right? It's still a massive market without any competitors on the borders. You have a very significant sort of, let's call it a transitional, you know, cyclical sort of population that comes to Virginia, you know, every summer that we benefit from. We have a number of changes that have been made to the medical program which make it accessible. So, you know, does Young King ultimately sort of veto this? I think the most important question, the most important fact pattern to that is look at Ohio. Ohio is a red state, has a Republican governor, is basically center right from a political landscape perspective, but they overwhelmingly approve legalization at the state level. So Youngkin is clearly in a political fight for his life. The Virginia Republican Party did not do well in the last election, and polling matters. So – and our issue polls better than almost every other issue out there because it's the only thing the Republicans and Democrats seem to – you know, hardcore Republicans, hardcore Democrats seem to agree on. So I actually am cautiously optimistic, but I'm even more optimistic because the market is great without any changes. So, you know, it doesn't – I don't think anybody at Columbia – or anyway, the cannabis company loses sleep over – over sort of whether or not Young Kim is going to sort of put his neck out on the political line, because I don't think the juice is worth the squeeze for him to do that.
spk02: Okay, great. I appreciate the call, and I'll go ahead and jump back in the queue. Thank you.
spk09: Please stand by for the next question. The next question comes from Frederico Gomez with ADP. ATB Capital Markets, your line is open.
spk06: Hi, good morning. Thank you for taking my questions. My first question is just on the margin track that you mentioned, you know, coming from the underutilization of your capacity. Can you remind us, you know, from which states that's coming from? And then, you know, heading into 2024, how fast do you think you can recover some of that margin Does it rely on the traction of your wholesale initiatives, or are there any other drivers here that can help that improve that capacity utilization? Thank you.
spk12: So let me hand that over to Derek, and I can fill in any blanks.
spk13: Sure, happy to. So the overall drag, as you referred to it, is five percentage points on our gross margin, and the background to that is where we have restructured and we've taken down canopy There are overhead costs associated with those facilities that just have to be expensed quarterly. We've restructured to take out the variable costs, but the fixed costs remain, and that's a pool of costs that can't be capitalized into inventory. In terms of the markets where we've got canopy offline and temporarily offline, it's primarily Pennsylvania. We've got some in New York. New Jersey, a little bit in Illinois, a little bit in Ohio, and a little bit in Virginia. So we've announced those as part of the restructuring program. Again, there's $38 million in annualized savings from a cash basis that they are part of. Now to the second part of your question on how that improves, we included in our prepared remarks today that there's some opportunities in 2024 as that cultivation gets turned on again, that we will be able to reduce that overhang of currently five percentage points. So yes, as we increase wholesale, as transaction volume continues as it has in Q3, there are opportunities to turn on some of that canopy, then absorb some of those costs into inventory and reduce that 5% to a lower level.
spk12: I mean, the one thing I would say about the sort of let's call it the – I think about it as if it's pre-funded CapEx, meaning we spent the money to build out the capability in anticipation of market dynamic changes. In Ohio, you know, if we hadn't made this investment already, we would be struggling right now to make the investment in time to capture – the value that will be created from the conversion to adult use. So I think that, you know, speaking to a question that was asked earlier, what lessons have we learned? The lessons that we've learned is that we need to be ready for the markets when they transition. You know, in New York, you know, there's excess capacity there. We did that intentionally because we believe that when the market opens up, it's going to be a significant market opportunity for us. The same in New Jersey. And so I think that it's important to remember, you know, a lot of the things that we're doing right now, whether it's wholesale, whether it's increasing our own our own retail network in many of these markets, or if it's simply taking advantage of the fact that the licensing structure is opening up and new operators are coming to the market that don't have their own supply chain. That's all very good for us because the regulators are effectively opening this bigot, allowing us to sort of capture a far greater market opportunity.
spk06: Thank you for the caller. My second question is just regarding your NCIB announced this morning. Could you expand on the rationale there for that and how it fits within your capital allocation framework, just considering some of the other options that you have in terms of debt repayment, but also growth investments like opening the stores, et cetera. So just how do you look at those options and why the NCIB at this point? Thank you.
spk12: Sure. I'll start off. I think it's very simple. We have a cost of capital at the company, and the cost of equity is the equity value and the equity, let's call it support we receive from our investors, is a leading indicator for basically the way the fixed income capital markets think about our company. The volatility we've seen in our stock has been frustrating for everybody. And there have been some technical reasons why we've seen that volatility, you know, portfolio issues, you know, within investors that had exposure to our name as well as others. And so that type of market opportunity comes along. And it's frankly, it's a great moment in time when the company should be able to take advantage of its balance sheet capacity and put it to work for the benefit of shareholders. there is no reason in the world why we should be in a position where we have to let the waves crash on our head when we have a program like this in place, and we do now. So I think the idea here is to be very methodical and deliberate in the way we allocate capital. We have a process internally that we go through to make these decisions. I think what you're hearing is that the board has spoken, and the board supports management, and management supports the shareholders along with the board. And we want to make sure that our investors recognize that This is the days of us having to kind of wait and sit on the sidelines are over. We have the ability and willingness to step in when and if necessary to provide the support and to sort of generate a return on capital that we believe is outsized relative to other opportunities in the marketplace, just based on what we see in our own portfolio over the next many, many months. So let me stop there for a second and see if Derek and Lee have anything to add to that.
spk13: Yes, so to your point on capital allocation, we are still very disciplined on how we are deploying capital, whether it's in cultivation sites. So those you heard, we've invested heavily to get ourselves ready for adult conversions in all the markets to the point where we've actually turned cultivation offline. We've got store openings that are planned that we've got capital to cover. We are reducing our debt, improving our interest savings as a result. So this is another Aspect to that capital deployment deployment option that we now have the ability to do in an environment where we're now creating positive operating cash flow So it's it's just another option for us to add to those deployment decisions Yeah, the only thing I would add is just you know, this is a tool that we haven't had in our toolkit previously so we now have this at our disposal and I think you know what you've seen for a
spk00: The cannabis company, as of late, has a disproportionate impact, you know, based on one particular situation, which is sort of a catalyst for getting this program in place, even though it's something that, you know, may have been warranted for quite some time. So, you know, obviously no guarantee that things will be exercised, but we want to have this available should it be the prudent move.
spk06: Thank you very much. I'll call back in a few. Thank you.
spk09: Please stand by for the next question. The next question comes from Ty Collin with A Capital. Your line is open.
spk14: Hey, everyone. Thanks for the question here. It was encouraging to see the volume growth kind of offset some of the basket and pricing pressure that you mentioned at the top of the call. I'm just wondering if you could elaborate on how much of that pricing pressure was sort of from your own efforts to reduce inventory levels and And then kind of following on that, do you expect to see pricing sort of firm up in the coming quarters as you get that inventory down to a more sustainable level?
spk12: That's actually a very good question. I'm looking at Derek right now. I have an answer I'd like to give, but I'm not going to get out and go. I'm going to punt it over to Derek.
spk13: Yep. So there's no perfect answer to this in the split on the average basket size decline and exactly who's coming into a retail location. who otherwise wouldn't have come in with additional discounting as we're working through inventory. But it's a meaningful impact in the quarter. We've seen average basket size declines in previous quarter reflecting the industry pressure on pricing. This quarter was a little more pronounced, and so it's difficult, again, to unpack it. But we're We're seeing high transaction volume increase to offset that, as you mentioned. That's encouraging. We're continuing to see that every quarter, and particularly in a place like Maryland, where we had doubling of transaction volume as a result of the conversion. So it's a little bit of an offset, but we're not expecting those types of moves to be consistent quarter over quarter from now on.
spk12: Guy, let me also add one more thing, and I'm going to look at the David and Derek, to kind of weigh in. What we've said in prior periods is that we wanted to take steps to basically clear through inventory to drive cash flow, which we've done. Some of those products were not high margin products, meaning they were basically bulk sales to go through that inventory quickly. And that came at a cost, and that cost was margin. And so from a cash flow perspective, you know, one of the things we had highlighted as a source of cash was working capital going forward. I think we've achieved that and we will continue to achieve that. But to your point, the idea is that we can kind of reset our inventory and our cost of goods sold to align directly with our strategy rather than the strategy of having assets that were either being sold to third parties or the company that was being sold to an external party, which may have had vastly different views on how to manage the business that we had to accommodate. So the whole point of us going through sort of this, let's call it post-transaction process, you know, clearing of the decks is to do exactly what you're suggesting, which is to put us in a position where we can see some improvement in gross margin and just to put us in a position where we have the products that we want on the shelves that we want in the inventory that we think are going to be, you know, more attractively priced, higher margin, and then we'll have a different demand profile, both from a wholesale and retail perspective. Is that a fair, a fair way to characterize it guys? Okay.
spk14: Yeah.
spk12: Is that, is that helpful?
spk14: Yeah. Yeah. No, that's, that's great. Appreciate the color there. And then just for my follow-up, Nick or Derek, I'm wondering if I could get you to elaborate on a comment that Nick made earlier in the call about ways in which you might potentially be able to manage the 280E component of your tax going forward, particularly in view of the potential rescheduling catalyst here. Just wondering if I could get a little more context on that remark.
spk13: Sure. So this is Derek. And in terms of the ongoing tax payments, we're continuing to make tax payments. Our income tax payable for the quarter was down versus Q2. So we're continuing to operate in the environment with 280E. The rescheduling that is anticipated to come out of Washington will move cannabis into a non-280E tax category. And at that point, we will have a much lower tax burden every quarter, every year. We're not clear on the timing of that. So there is a rescheduling announcement, and then there will be an IRS announcement. Typically, those things go hand in hand. But from our perspective, we're not relying on the IRS to retrospectively give us a large tax refund. We're anticipating that will be implemented, but it will help our net income figure. It will reduce our tax burden. And obviously, improve our operating cashflow position beyond what is already turning positive.
spk12: One very simple sort of way to think about it is that, you know, in the quarter about 88% of our revenue came out of our retail network. That's a significant exposure to 280E because SG&A is where you get smoked on, it's the distribution piece that really gets affected by 280E. As we move more so into wholesale, That will have a variety of impacts in terms of allocations and, you know, sort of all the things that go into the way kind of the ultimate tax bill and the taxation is calculated. So that should improve, you know, just based on that alone.
spk14: That's great, guys. Thanks for that.
spk09: Please stand by for the next question. The next question comes from Matt McGinley with Needham. Your line is open.
spk03: Thank you. My follow-up is on kind of some of the comments you made on gross margin. Does the discounting impact have less of an impact in the fourth quarter, and can you improve gross margin sequentially from what you reported in the third? And then I guess exclusive of that five-point impact you mentioned from absorption, you also had restructuring and manufacturing that will improve your efficiency. Because I think about all those things in totality, like you have a few of these states you mentioned that won't likely see higher utilization in 24. And so those absorption impacts probably don't go away. But there's this restructuring impact, but I'm not sure how near term that is and how meaningful that will be. and then compounded with the relatively, I assume, less discounting from a cleaner inventory position. So you mentioned a couple of impacts here, but I'm just not sure how meaningful these are. These are very near-term impacts, or these are things we're not going to see for quite some time on the gross margin side.
spk13: Yeah, happy to address that. And yeah, there's a lot of factors that you mentioned that are all working in conjunction here. As we move into Q4, we're still working through some of this excess inventory. So there will continue to be a drag on gross margin in Q4 as we're working through that. That is to reduce inventory that was built up arguably during the arrangement agreement with Cresco where we were building inventory in certain states that we'd be disposed of, that would be part of integration. So it will take a couple of quarters to work through that. As we turn to 2024, when inventory will arguably be reduced down to more normal levels, then yes, we will have those catalysts of increased utilization at cultivation sites as we turn on more wholesale opportunities, as we continue to see transaction volume, and we'll eat into that five percentage point overhang of underutilized, in addition to the benefits from no longer having to overly discount inventory in the retail and wholesale markets?
spk12: Matt, one way to look at it, and Derek, you can correct me if you, please correct me if I misstate something. The idea is that we would finish up any kind of changes, structural changes to the business in fourth quarter in anticipation of 2024. So, you know, we've certainly seen an increase in demand of our products, right, because, you know, particularly among the branded and refined products, both from a hotel and a retailer's perspective. And that's helping with the absorption accounting issue we've referenced. But we're not anticipating a huge impact until we're sort of finished cleaning the decks. And I think that happens, that work is done in 4Q. So, you know, are we expecting, you know, stability in gross margin? Yes. are we expecting, you know, a massive, you know, improvement in gross margin? Not until 24. But, you know, that's a bit of turning the ship. Remember, the minute we open up a dormant room in a facility and we start planting plants, we don't recognize that sort of allocation of the absorption of overhead until the plants harvest it. So, you know, we were sort of Eight weeks, you know, with eight weeks in the third quarter, you know, even if we planted plants the day the transaction ended, we wouldn't be able to sort of, we wouldn't recognize that until, you know, until sometime at the end of the fourth quarter. So there's just a timing issue here that relates to how all of this gets accounted for. But, you know, that's why we're really focusing on first quarter, first half of 2024. Got it.
spk03: And then with the changes that you mentioned you're making to the wholesale program, are you gaining traction with distribution and more retail doors? And I guess what can you point to that gives you optimism that this part of the business isn't just stable, but you'll be able to grow it from here?
spk12: Let me turn that over to Jesse. Jesse, why don't you weigh in on this?
spk08: Yeah, I mean, look, I think as we mentioned in the call and sort of as we spoke to, this is this is an entirely new sort of effort with regards to an organized national wholesale approach, which has been something that has not historically been, I would say, an institutional strength, right? And so with the leadership in place now with team members basically being fully staffed, we're already starting to see traction with not only conversations, as mentioned on the call, at the enterprise level, so the way in which we're approaching partnerships with other multi-state and large single-state operators, but also with the more fragmented retail supply chains, like something like in New Jersey. So I think in the coming quarters as we move into next year, we really will start to have significantly more data to back up, obviously, what we are already seeing directionally and conversationally that's happening on these calls and in these meetings right now. But I think there's no question that that is a significant opportunity for us moving forward and somewhere where we're already starting to see those returns and building some strength. Thank you.
spk09: Please stand by for the next question. The next question comes from Matt Bottomley with Canaccord. Your line is open.
spk05: Good morning, everyone. Just wanted to touch on two markets, New York and Pennsylvania. So Nick, maybe just following some of your commentary on New York, I'm just wondering, you know, nothing specific to cannabis guidance or store openings or market opportunity, but just, you know, where you think the moderate to upside or maybe the bullish side is. for that market overall, just in its structure? Is it sort of these bodegas that are, you know, need to be closed down that are selling cannabis? Is it, you know, conversion of illicit to legal? Obviously, store openings overall that are legal would be nice, but what's your expectation or hope for what 2024 looks like specifically in terms of what that environment might look like?
spk12: I think it's really three things. First, the The licensing process that we just submitted the applications under will resume for non sort of let's call it incumbents, meaning all of the other licenses that need to be issued for operators that would increase the market size and the access to a regulated market would resume. And that's going to create sort of let's call it a demand profile of some sort for wholesale. The value proposition, and I'm sure you've seen this in states like Maryland, the fentanyl issue is real. And the problems with the supply chain and the illicit markets seem to be doing a wonderful job of blowing themselves up. Not to say that that's a panacea, but the combination of basically, not surprisingly, the illicit market poisoning its own consumers for a quick buck and enforcement, which is now not only going after just the operators, but also going after the landlords, which in New York state is, you know, it's like sacrosanct, right? The landlords decide where you can, where you can and cannot live. And they are now squarely in the targets of the regulators. All of that's very positive. And I think the fact that, you know, Hochul and Adams and the rest of the sort of let's call it the leadership cast in New York State recognize that this is a very, very simple way to fix a massive budgetary hole. All kind of convalesced at a point where the marketplace that we would be a participant in ought to be attractive. Now, how quickly that moves, that sort of expands, I'm not sure. And I think that our product offering is far more attractive than what the hemp producers could have ever produced. I think that the market, there is a pent-up demand for licenses amongst many of the operators. And I think that, you know, just being able to increase the access point through our own dispensaries will have a huge impact on our business in New York because the business has really languished over the past two years. So, you know, do I have expectations that, you know, that point to an outcome like the state of Illinois? No. But do I think eventually it gets there? Yes. The question is, how much time does it take? And, you know, it's, I think that that is something, you know, typically in New York, it's a little bit like turning an oil tanker. It takes some time. So we're, I think we're cautiously optimistic, right? It's another way to leverage existing infrastructure and fixed assets. And I think that the, you know, we happen to have the best supply chain out there from a wholesale perspective. So that's, I think that's, you know, that's a positive outcome.
spk05: Great. Appreciate all that. And then just the other market I mentioned was Pennsylvania. So that seems to be a region in Q3 reporting that a lot of MSOs, at least in their prepared remarks, haven't really touched on a lot. We know there's historically some wholesale headwinds there. It's still in your top five from an adjusted EBITDA profitability or dollar standpoint. I'm just wondering if you can give any more updates on where that market is, how you look at its growth into 2024, and where pricing kind of looks to be ending the year relative to in earlier quarters this year where we know there was some pressure.
spk11: David, I'll take that one. We continue to be enthusiastic about our ability to retail in Pennsylvania with our three doors. I know we are underscaled with the retail footprint relative to some of our competitors, MSO competitors, but those stores have continued to deliver from a performance perspective, so kudos to the Pennsylvania team and the locations. And we obviously have a large cultivation manufacturing facility that's a legacy G-leaf operation. And we did a lot in the last two quarters to take canopy down to reduce our cost in that facility and are working on not only increasing the throughput on the cultivation side with potentially putting more plants under lights as we're seeing some demand for what we're bringing to the market, but incremental throughput on the post-harvest side on the manufacturing product category basis. We're, I would say, cautiously optimistic about Pennsylvania in 2024. We'd probably love to be, you know, have a larger footprint there when the opportunity presents itself. But we've done a lot to right the ship from a back-of-house perspective to prepare for the current medical program environment, but also as we think about what adult use could look like in that marketplace. And I think we've got an asset that's kind of unrivaled in the state for when adult use comes. Okay. Appreciate all that. Thanks.
spk10: Please stand by for the next question.
spk09: The next question comes from Andrew Simple with Ecolon Capital Markets. Your line is open.
spk04: Hi there. Good morning. Thanks for taking my question. So you spoke to cash flow prioritization in the prepared remarks. Just wondering on the back of that whether you've got any idea what the CapEx budget might be for 2024. Obviously, the pace of that's been declining this year as major projects have wrapped up. And in particular, are you planning to make any investments in states ahead of possible adult use catalysts, most notably Ohio and Florida? What are your plans in those two states?
spk13: Yeah, so this is Derek. I'll take that. So Q3 capex, $2.5 million, fairly consistent with what we've been doing in the last few quarters at a much lower level than we've had historically when we were building out markets in anticipation of adult use. So we're not expecting major changes to that figure quarterly. We do have new stores that are opening that we're supporting. The major investments we're making are upgrading manufacturing capabilities, continuing to keep our cultivation manufacturing sites maintained. We're not yet to the point of providing guidance for next year, but we anticipate staying at these low levels with a needed investment in new stores as we open them. To the extent we add stores in Ohio based on adult use, that'll be an incremental capex spend, obviously a good return on investment anticipated for that. other markets as well, and will be opportunistic as we look to other markets as they evolve as well.
spk12: The only thing I would add is the real capital intensity has already taken place, so we don't need to add any cultivation capacity, any manufacturing capacity that would be material in nature at all. The, you know, the per-square-foot build-out costs for, you know, our third dispensary in New Jersey is de minimis. And so, like, we're not anticipating a spike in CapEx or a use in proceeds to sort of go forward and turn on some of those dispensaries because we don't need to. So, it's – I think that the bright side is, like, sort of the CapEx ought to stay at a fairly reduced rate because – We're not opening up any new markets, and that's obviously a disproportionate cash flow impact. We also don't need any more cultivation and manufacturing capacity, which on a per-square-foot basis is the most capital-intensive part of the business. From this point on, it's really just leveraging existing infrastructure, and obviously as we open up new retail stores, it gives us the ability to begin to sort of eat away at that absorption accounting issue that Derek mentioned earlier.
spk04: Great, that's helpful. And then maybe for a follow-up, if I could ask for a little bit of additional color on one of the more opaque state markets, which is Virginia. How have the patient counts been trending in that state? Have you continued to see a pickup as regulators of these barriers to patient sign-ups, or are you beginning to see that slow down a little bit in the third quarter? And what's the expectations going forward?
spk11: Yeah, I'll take this one. This is David. You no longer have to actually register with the state as a patient. So, you know, this is from our perspective, we're measuring transaction volume and basket sizes and door openings. As any sort of emerging medical program, pick a state, number one determination in terms of PAM is doors opening. And so we continue to be focused on getting the next two open so that we can continue to provide patient access. So every time we've opened a door in our two regions, we've seen an increase in patient count, if you will, or transaction volume. So we're still very optimistic about the total medical program opportunity in front of us. prior to adult use and see the return coming from the doors that we've opened and that we continue to focus on for the next two in early 2024. Great.
spk04: Thanks for taking my questions.
spk09: I show no further questions. This concludes today's conference call. Thank you for participating. You may now disconnect.
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