The Cannabist Co Hldg

Q4 2022 Earnings Conference Call

3/29/2023

spk04: I'd like to take a moment to share why I have such confidence in our ability to capitalize on our unique position. First, we will accelerate growth by opening the remaining dispensaries in Virginia, West Virginia, New Jersey, and Maryland. Our cultivation and manufacturing is already scalable to capture wholesale opportunities, and we have expanded the capabilities in every market to produce concentrates, edibles, and higher margin branded products that our customers and patients want. Every wholesaler needs access to retailers. we can provide that access and intend to do so in an equitable manner that allows us to sell our full suite of products and brands into other retailers in order to develop brand leadership positions around the country over time. Second, we have implemented 60% of our restructuring plan, with the remaining cost reductions and operational synergies coming later this year. This gives us line of sight on EBITDA margin improvement and lays the foundation for the next phase of our plan to drive cash flow, recapturing gross margin points over the next 24 months by leveraging the scale of our cultivation and manufacturing assets around the country. Third, we believe we have the potential to drive adjusted EBITDA margin higher in the midterm as the business operates with the new cost structure. There is additional opportunity for improvement upon further optimization of cultivation. This includes utilizing available square footage, launching improved products, brands, and SKUs into the wholesale market, and leveraging our expanding retail channel, as well as implementing better systems to improve quality and reduce the absorbed costs on every gram sold. And fourth, We have retained a talented professional team that operates with integrity and is passionate about the opportunities that lay ahead in cannabis at Columbia Care. The leadership team has taken the past 12 months to review and assess every aspect of our business. In spite of the headwinds, our market continues to grow. My enthusiasm is a reflection of the entire team's perspective. As we pursue a pathway to a transaction with Presco, we look forward to executing on our potential and delivering the most attractive platform in the sector to all of our partners and investors. ColumbiaCare is uniquely positioned with embedded best-in-class growth, the right positioning for our market conditions, and high potential for margin improvement. We are excited for the road ahead and the opportunity to build substantial shareholder value. With that, I'll turn it over to the call of Derek from New York Financial Results and outlook in more detail. Derek?
spk05: Thank you, Nick, and good morning, everyone. I'll provide a summary of the key financial results for the fourth quarter and the full year of 2022. discuss the key trends we're seeing in our markets, and comment on the pending CRESCO transaction. For the full year, we achieved a record $512 million in revenue, representing growth of 11% over 2021. Revenue in the fourth quarter was $126 million, a decrease of 5% sequentially versus Q3. The decline over Q3 was driven almost entirely by wholesale pricing in a challenged environment that all MSOs exposed to wholesale have been experiencing recently. Our retail revenue was flat quarter over quarter despite continued pricing and discounting pressures in certain markets and reflected another quarter of solid retail transaction growth. In the fourth quarter, we added a net one new retail store with two new store openings in Virginia and one closure in Colorado as part of our broader restructuring efforts. More about that in a moment. In Q4, our retail revenue was flat sequentially, while wholesale revenue declined 30% sequentially and represented just 12% of total revenue in the quarter. Average basket size, which is a combined measure of pricing, discounts, and share of wallet from customers at our retail stores, decreased quarter over quarter, but at a slower rate than we experienced in Q3. As we've talked about before, 2022 was a challenging year for consumer spending. with pricing down in a number of key markets and inflationary pressures resulting in a lower share of wallet available to spend in cannabis stores. The industry continued to grow in 2022, but at a slower pace than anticipated at the beginning of the year. Despite that, the long-term fundamentals of the industry remain strong. Once again, we saw continued growth in our emerging markets, like New Jersey and Virginia. with Virginia now joining Colorado as one of our markets, contributing over 10% of revenue during the year. Pennsylvania, California, and Colorado continue to be challenged and declined again sequentially, but we've started to see stabilization. Adjusted gross profit for the fourth quarter decreased sequentially to $47.2 million, down from $56.9 million in Q3, resulting in an adjusted gross margin of 37.4%, also down from Q3. Our Q4 gross margin was impacted by lower pricing, particularly in wholesale, and also due to unfavorable absorption at underutilized cultivation sites that require us to expense cultivation overhead costs rather than capitalizing them into inventory. For the full year, our gross margin was 39.3%, with an adjusted gross margin of 42.4%, the difference primarily being inventory write-offs at facilities we closed in Colorado as part of our restructuring. Our canopy reduction will continue to generate cash savings, but will also create an unfavorable impact on gross margin in the short term while these assets are underutilized. Adjusted EBITDA for 2022 was $67.4 million, bringing our full-year adjusted EBITDA margin to 13% and up 60 basis points from 2021. Adjusted EBITDA was $17.4 million in the fourth quarter, or 14% of revenues. Despite an adjusted gross margin decline in the quarter of 5.5 percentage points, EBITDA was only down 2 percentage points as our restructuring initiatives continued to lower SG&A. To expand on the topic of restructuring, we took early and meaningful steps throughout 2022 with three separate rounds of initiatives. Our latest cost-saving initiative announced in early January reduced or exited cultivation operations in six of our markets, closed four unprofitable retail stores in Colorado and California, and eliminated approximately 25% of our corporate overhead positions. This latest initiative is anticipated to generate a net $35 million in annualized savings alone. On to our liquidity. We ended the year with more than $48 million in cash, having burned less than $2 million in the fourth quarter, a result of cost savings, lower CapEx, and improved working capital management. Capital expenditures in the fourth quarter were approximately $3.4 million, down from $11.9 million in the third quarter. For the full year, CapEx was $73.8 million. During the fourth quarter, we generated $5.2 million in positive cash flow from operations. A number of other liquidity initiatives are also worth noting. As we announced yesterday, we've extended the maturity on all 38.2 million of our 13% notes, which are now due in May of 2024. This extension was done under the existing indenture agreement and did not require consent or fees. There are no additional maturities in the short term until December 2023, when less than 6 million of our convertible notes become due. As a reminder, we also have capacity under our existing indenture that would allow for additional senior secured financing, should we need it. During 2022, and as disclosed in our 10-K filing, we reduced our overall cost of capital on our senior and commercial debt positions in a year when interest rates were rising. In 2022, we also negotiated a lower interest rate on any future capital lease needs and reduced the finance lease obligations disclosed on our balance sheet by over $18 million. We've not taken on any significant liabilities since announcing the CRESCO transaction. In summary, we took early and meaningful actions to strengthen our balance sheet and make operating adjustments necessary in the current environment. This has created a clear path to positive free cash flow, building on the positive operating cash flow we achieved during Q4. So far in 2023, we've taken further steps to optimize our asset base. As Nick mentioned earlier this month, we signed a definitive agreement to divest our interests in the Missouri market. One dispensary and one processing center for a total consideration of 6.9 million. 3.5 million of this has already been paid on signing of the agreement in March. As we're well into the first quarter of 2023, we can say we expect a revenue to be slightly down sequentially from Q4, which is consistent with normal seasonality and would represent low single-digit growth when compared to the first quarter of 2022. We're maintaining our focus on cost management discipline preserving cash, and deploying capital efficiently. In Q4, the majority of CapEx supported store openings and cultivation projects in growth markets, and will continue spending on similar priorities in 2023 to support continued growth. As we've mentioned, and as you heard on the Cresco earnings call, we continue to support Cresco as we move towards closing of the transaction, and we look forward to the growth that ColumbiaCare's portfolio will bring to the combined company. Despite the delayed timing of the Cresco transaction, and as you've heard today, we've independently taken actions to make ColumbiaCare stronger and will continue to execute on initiatives to strengthen our business through closing. With that, let me turn the call over to David to cover operational highlights. David.
spk02: Thank you, Derek. I will now highlight important operational developments during the fourth quarter, particularly in our top markets. On a revenue basis, our top five markets alphabetically were California, Colorado, New Jersey, Ohio, and Virginia. On an adjusted EBITDA basis, our top five markets were Massachusetts, New Jersey, Ohio, Pennsylvania, and Virginia, with Massachusetts replacing Colorado since Q3. I want to highlight that New Jersey and Virginia both remained in the top five this quarter, further demonstrating the strength of our emerging markets. As Nick mentioned, in Q4, we leaned into cash preservation and inventory management, which negatively impacted gross margin in the quarter. In cultivation, we remained focused on increasing quality and potency while lowering our production costs per pound. During the quarter, we continued to optimize production planning, genetic selection, environmental controls, and plant management across the portfolio. A number of our markets are seeing improved potency THC percentages through strict adherence to SOPs, and have identified numerous high-potency strains of 26% THC or greater. We currently have over 68 high-potency strains in our library with plans to increase our genetic diversity in the coming months. On the manufacturing side, we are ramping the production of concentrates in the portfolio and launched heady edibles in the beginning of Q4, followed by our cannabis tablets under PRESS 2.0. We continue to expand SKU and product offerings in each of our markets as we meet customer and patient trends. Now to discuss a few markets in more detail. In California, we closed our downtown LA dispensary and cultivation site in January as part of our efforts to optimize our portfolio as pricing pressure has stabilized but nevertheless persists. In Colorado, we took down a significant amount of canopy and closed one store during the quarter. We saw a sequential decline in sales as compared to Q3 due to competitive pricing, lower average dispensary sales, and decreased transactions. Colorado was the focus of restructuring efforts during the first quarter of 2023, where we've continued to drive efficiency and cut costs by beginning to wind down several cultivation sites. We've closed a total of four retail locations in the state, yet still remain a leading market position with 23 active dispensaries. Turning to Massachusetts, where we saw a sequential improvement in gross margin as we continued to optimize automation and streamline processes throughout our manufacturing facility. We launched numerous SKUs in 2022, including roll your own pre-roll kits, triple seven and seed and strain popcorn and press 2.0. The market continues to see wholesale pricing pressure, mainly in the flower category. In New Jersey, revenue was up 150% in the second half of 2022 due to ramping adult use sales and strong wholesale opportunity. Our cannabis locations in Deford and Vineland were some of our top retail locations in our portfolio in the second half of 2022. During the quarter, we introduced multiple SKUs, brands, product line extensions, and flavors, including Dablicators and Amber Hash. We achieved automation for flower and pre-rolls at our second cultivation site in the state, which helped streamline production to meet strong demand for the adult use market. In Ohio, we saw an increase in internal deliveries to our own stores, which led to a significant expansion of shelf space, providing us a platform to reintroduce genetics and overall quality to the market with increasing competition. 50% garden canopy reduction late in the fourth quarter helped to mitigate an overabundance of finished products. We also introduced strain-specific CO2 carts and RSO duplicators under seed and strain brand during the quarter, which provided more product diversity and allowed us to increase internal sales year over year. New operators are set to open throughout 2023, which we expect will lead to an increase in wholesale opportunities for production, as well as an increase in competition for our retail portfolio. We remain optimistic that our introduction of high quality products in the market will position us well as competition on the retail front intensifies. Turning to Pennsylvania, revenue is down sequentially due to lagging wholesale demand, but we saw an increase in adjusted EBITDA margin as we skewed toward retail. One of the biggest changes to canopy capacity as part of our January restructuring initiative was the reduction of canopy in the 270,000 square foot facility in Saxton, Pennsylvania. We retain optionality to scale up when marketing conditions warrant. Finally, turning to Virginia, which continues to be a top market for ColumbiaCare. During the fourth quarter, we opened two new cannabis locations in Richmond and Williamsburg. Virginia expansion has continued in 2023 with two additional openings thus far. We have eight retail locations open to date with four more in development. Revenue in Virginia has increased nearly 100% year over year. We are still seeing double-digit growth on a quarterly basis as the medical program continues to expand. In a state with more than 8.5 million people, there are currently just 55,000 patients registered in the state, or about 0.6% of the population. We're seeing that number increase as the program has become one of the most accessible medical programs in the country. There's significant room to grow the patient population, and we look forward to serving them as we add additional retail locations in the Commonwealth. In closing, I'm pleased with the progress that our team has made in all of 2022. We've carried our momentum into 2023 with three new store openings so far and are determined to ensure we are well positioned in growth markets with a strong retail footprint. We will be ready to hit the ground running as adult use comes online in more states like Maryland in the future. I will now turn the call back to Nick, and we will take your questions. Nick? Thank you, David.
spk04: We look forward to taking your questions. Operator, can you please open the line?
spk00: Thank you. If you'd like to ask a question, please press star 11. If your question has been answered and you'd like to remove yourself from the queue, please press star 11 again. One moment while we compile the Q&A roster. And our first question comes from Aaron Gray with Alliance Global Partners. Your line is open.
spk08: Hi, good morning, and thank you for the questions. So first question for me. Good morning, good morning. Just want to dive a little bit into the margin during the quarter. Could you quantify maybe how much of a drag there were from some of the markets that you've exited some of the research cultivation like California, Colorado, Pennsylvania during the queue and mostly just trying to better conceptualize how we think about margin improvement in the near term that you kind of spoke to and how much color we might expect as you kind of shift in and capitalize on some of those things you mentioned. Thanks.
spk04: Why don't I start off with a very high level sort of comment and then I'll turn it over to David and Derek to sort of fill in the gaps. Obviously, what we suggested is that the totality of the restructuring today culminates in about $35 million in a reduction of overall OPEX. And so that ought to flow to the bottom line. Part of those changes in OPEX related to reduction in canopy. And we still have the same footprint. We still want to preserve the let's call it the call optionality associated with the square footage. And we have some approaches that we're actually activating now to sort of reignite the need to sort of activate that canopy over the next 24 months. but there will be an absorption accounting issue that has to flow through from gross profit. So although you see sort of a significant improvement in SG&A as a percentage of revenue, you'll also see sort of an offset in the form of the absorption accounting that gets spread out through our gross margin. Now, we're focused on gross margin now, that we're sort of wrapping up the SG&A piece of the restructuring puzzle. And so we feel confident that there's a very, very clear path to help us get there. The net outcome should be positive. But if you want to sort of, let's say, you want to isolate, you know, Missouri, like we were losing about a million dollars a year in EBITDA in Missouri. And so that obviously reverses, and it's also a source of liquidity for us, which is two good things that are meaningful. If you think about Puerto Rico, Europe, everything that we closed was negative in terms of EBITDA contribution. So it was a very deliberate attempt to kind of cull the portfolio and reduce our exposure to anything that wasn't contributing at the level that we wanted it to contribute. So, I don't know, Derek and David, if you have anything to add to that or if you can provide some additional sort of specifics to help Aaron.
spk05: Yep. Thank you, Nick. And hi, Aaron. So, as you pointed out, there was certainly a significant impact on growth margin in Q4 as a result of the restructuring and as a result of the cultivation takedown. Our adjusted gross margin in Q3 at 42.8% going down to 37.4% in Q4 is a reflection of that. So that's about five and a half percentage points. We don't treat the under-absorption of cultivation sites as an adjusted EBITDA at-back that just flows through cost of goods sold, as Nick said, as part of absorption costing. So in the short term, I'd say that five and a half percentage point swing is something that we'll be experiencing until, as Nick says, we bring that cultivation back online and we're past this restructuring that we've initiated in Q4.
spk08: Okay, great. Thanks very much for that, Keller. And the second question for me, I just want to speak a little bit on Virginia. I know it's a strong medical market for you guys right now, but with adult-use regs stalled, can you speak to how you now approach the market in terms of investments You mentioned continued building out the full allotment of retail, so more so on the cultivation side, how you look to approach the market with more uncertainty in terms of when adult use might come and the insight you might have in terms of the prospects of adult use income online for the rigs as well. Thank you.
spk04: Well, let me – first off, I'm going to turn it over to David in a moment, but Virginia is a very attractive market. For those of you who remember the way Massachusetts or Arizona evolved, I think there are some very sort of important similarities in that you have a far – a far more limited sort of cast of characters that are actually operating in that environment. You have a very large total addressable market, and you've got a state that's basically opened up the medical market as wide as it possibly can. So we built out our infrastructure, and we continue to build out our infrastructure because there is substantial unmet demand throughout the state. in all of our areas. The manufacturing cultivation piece is something that was already scaled. So if we have to, if the regulations sort of surface to transition to adult use, That's not something that's going to require us to – it's not going to require a lot of time or money for us to convert our operations because we'll already be ready for that transition point. But in the meantime, what we see is, frankly, even – you can use Pennsylvania as an example. You see a very, very reasonable framework for the medical market that is growing at an enormously fast clip. And we're basically poised to take advantage of that growth, and it's been a very good market for us, and it will continue to be a very good market for us. You know, it's whether or not we have adult use regs surface in the next, let's call it six to 12 months, I don't know. But our model and our expectations aren't built on that because we always knew that there was a legislative change that was required to move that path forward. So, you know, think about if you had a state the size of Illinois, but you have four operators, for all intents and purposes, that's kind of the market opportunity set for us in the state of Virginia, and we're very excited about that. So, you know, I think heads we win, tails we win, and that's one of those few moments in time when you can really say that with a great deal of confidence. I think that there is pressure to continue moving towards adult use. But at the same time, there's also pressure to continue expanding the medical program and making sure that access is there and unfettered access, more importantly, is available to anybody who needs to be a participant in the program. But David, maybe you can add some color.
spk02: Yeah, the only thing I would add is we've continued to be focused on building out the retail footprint. We have been deliberate in attempting to find viable locations, not only for the medical program, but that we think will be ideally positioned for an adult use framework as well. So that is why we still have several facilities in final stages of being identified and built out. So that will occur in 2023. And as Nick mentioned, on the manufacturing and cultivation side, we have two locations, both of which have been essentially fully built out and are operational. The team on the ground on a day to day basis continues to see organic growth every time we open a new door from Richmond down to the southern border and out to the East Coast. And so we continue to benefit from the organic growth opportunities of just providing incremental doors for access for patients. And the team is hyper focused on, you know, canopy. THC level increases and genetic diversity and concentrate brand launches commensurate with other states. So it's no change to the operational plan in Virginia over the last 18 months or so. It's continued to execute until the adult framework comes our way, of which we'll be well positioned for.
spk08: Okay, great. Thank you very much for the call, and I'll jump back to the queue.
spk00: Thank you. Our next question comes from Scott Fortune with Ross MKM. Your line is open.
spk01: You may be on mute. Operator, maybe we should come back to Scott and go to the next question.
spk00: Can you not hear him? I can hear him.
spk01: We can't hear him.
spk00: Okay, one moment.
spk01: Scott, your line is open. Sarah, can you hear me now?
spk06: Scott, how are you? We hear you great. Thank you. Sorry about that. I don't know what happened there. Real quick, just wanted to provide a little bit more update. Obviously, the wholesale side is weak versus the retail side. How do you see the mix going forward here with the verticality? Are you kind of fully stretched out now on your verticality for these states, or do you still have some room to sell your own products in your own stores? And with that, how are you looking at New Jersey? You mentioned before kind of more doors opening up in the first half of 2023 and the wholesale opportunity, just kind of a better sense of wholesale opportunity and that mix going forward as you see that starting to improve.
spk04: So let me turn that over to David. But before I do, I think that in terms of the infrastructure, just the raw infrastructure to participate in the wholesale market and the retail market, we feel very good about the CapEx we've spent sort of over the past several years, and we're well positioned to take advantage of that. Obviously, with the merger on the horizon, It's changed – it's forced us to see the world through a very different lens because we haven't had sort of – the decisions we're making are decisions in collaboration with CRESCO. But what I can tell you is that knowing that we don't have a defined timeline based on the regulatory elements of the approval process, what I can tell you is the following. on a steady-state basis for ColumbiaCare, you know, as just a unique, independent entity. The way we approached the restructuring, our own restructuring, was to first get our SG&A in line with where we thought it should be, which I think we're getting close to. Now that we've done that, we've also, at the same time, run a parallel path to improve our quality of manufacturing and cultivation and actually introducing products that give us the full suite of SKUs that we really need to be competitive in each market. With that sort of combination and knowing that we're leaning into a number of markets where we do have leadership, like New Jersey, like Virginia, it allows us to really horse trade more effectively and participate in the wholesale markets to a much larger degree. And so, historically, we've always under- indexed in the wholesale market. I think what you'll see is that we intend to move that indexing north, but because we have a retail orientation, you're always going to see us sort of expanding not only into our new facilities, but maintaining share and obviously we're seeing increased foot traffic coming through our dispensaries. And all of that helps us from a brand building and from a margin perspective. I think a rising tide lifts all ships. We're seeing that through the retail channel, but that retail success, we believe, is going to also translate into wholesale success because of the steps we've taken on a parallel path over the past 12 months. David, do you want to weigh in?
spk02: I would just highlight, as I look at This year, the trends at the end of 2022 and heading into 2023, I'd highlight seven states where there is wholesale opportunity for us that's organic in terms of growth prospects. Colorado is pricing dependent. We obviously took some restructuring initiatives in Colorado and have focused on putting own product on our shelves in 2023. Depending on the pricing environment, we always have the opportunity to actually lean into the wholesale market if it makes sense from a revenue and a margin perspective, but the priority is with our 23 doors. If you look at Illinois, there's obviously new doors opening. We have made some changes to our wholesale go-to-market strategy, one of which has had probably the most pronounced impact, which is not providing exclusivity for new products or new genetics in our own doors and allowing wholesale partners to participate in those exclusive drops, and that has had a pronounced impact on our opportunity and our go-to-market strategy in Illinois. In New Jersey, as Nick mentioned, there are a number of new doors opening. We've established relationships with over 70 new doors that are opening in New Jersey, and so we're in constant dialogue about day opening and initial inventory asks, and so We're hyper-focused on capturing that new incremental market share in New Jersey. In New York, we've launched a number of new products. We've seen an improvement in our flower quality out of Riverhead and Long Island, which has resulted in incremental wholesale opportunities, and we were the first to market with a 25-meg concentrate, which has been well-received in the wholesale market. Ohio, I think Nick also mentioned, we've got new doors opening. We've got increased THC profiles and genetics in Ohio, which is having a favorable impact on our business right now. And then lastly, West Virginia, new doors are opening, and we are essentially the ax in the wholesale market in West Virginia. In 2022, we will be in 2023. And one we probably don't spend enough time on, but we're clearly excited about is Maryland going adult use probably in July. There's going to be an incremental opportunity. I think we're well positioned there from a flower and concentrate perspective. As Nick mentioned, it's been a relatively low percentage of our total business because of the expansive retail footprint that we've had historically. But we do see the opportunity to begin to lean into the wholesale market opportunities in a number of states where flower quality, THC profile, genetic expression, and concentrate skew makeup is impactful. And so I would argue we're starting at a low base, so we've got an opportunity to take market share, particularly in markets where organic growth is there to take.
spk06: I appreciate that color. And just following up on the Maryland market, you mentioned, obviously, CapEx reduction, primarily going to adding new stores, Virginia, and such that you mentioned. But how are you looking at the Maryland market and the confidence that they'll start here in mid-this year and the kind of opportunities in the Maryland market? Obviously, we've seen pricing come off there, but have we seen any stabilization on the pricing in the Maryland market, unfortunately?
spk04: So just a couple of very high-level thoughts. I mean, I think Maryland, for us, we're looking at it both from a retail and a wholesale perspective because we still have that PG County dispensary that we'd like to develop that we're pursuing the site for right now. And I think we're cautiously optimistic that the way the regs shake out will be a net positive for all operators. The fact is you're going to see a fairly substantial expansion of the Maryland opportunity. We've seen some price declines over the past, let's call it, several quarters in Maryland, and that's made it somewhat challenging. But our infrastructure there is very well suited for a conversion point, which is kind of where we are right now. And we would expect that, you know, the participation in the wholesale market that we've seen historically is something that will, you know, that will certainly be, you know, facilitated by the transition to adult use. But David, why don't you weigh in?
spk02: I would just say the assets we have there are purpose-built for adult use conversion. So we've got a very stable cultivation leadership team down there, which is still being operated by the GLEAF team. But we've recently completed the build of a manufacturing facility, which is essentially adjacent to our cultivation facility. So we've consolidated the back of house, if you will, into one region in Maryland and gained some incremental scale on the manufacturing side. So I think we're well-positioned for For adult use and as a company, we've been through a number of these transitions and conversions. So I think we're well prepared for it and looking forward to it.
spk06: I appreciate the detail. And congrats on extending the debt from there. I will jump back to you. Thank you.
spk00: Thank you. Our next question comes from Glenn Mattson with Leidenberg Thalmann. Your line is open.
spk03: Yeah. Hi. Thanks for taking the question. Just a quick first on the model. I think Nick at one point talked about extending the debt maturity allows you guys an opportunity to rebuild the cash position. So I guess you're implying inherently that you'll be free cash flow positive for the year. I'm just kind of curious of some of the components of that. Would you expect like working capital reduction would be as maybe on the inventory side in particular and then just more specifically on what the CapEx expectation is for this year?
spk04: So let me turn that over to Derek. I think he's probably best positioned to answer that. Go ahead.
spk05: So on the working capital side, with cultivation coming offline, we have the opportunity to reduce inventory with the overall industry not growing as much as we'd anticipated. So yes, there's an opportunity to reduce inventory and free up working capital from that perspective. The CapEx initiatives that we've talked about, certainly in the last two years, we've built strong and early. So the CapEx focus for 2023 will continue to be at a lower level, but while still supporting some of the manufacturing process build-outs in our growth markets and obviously the store openings that we've got anticipated on the East Coast. So that is the path to free cash flow positive for 2023. And as we've mentioned in Q4, we've already hit that operating cash flow positive position based on a number of initiatives that we've taken towards the end of the year.
spk04: The only thing I would add is that... Go ahead, yeah. The only thing I would add is that in the first quarter, you would expect to see some cash-based charges because of the restrictions we went through. Those are obviously one time in nature. But, you know, that's just – that would be the only kind of anomaly in the plan. I mean, I think when you look at the improvements, if you just run out gross margin of kind of where it is right now and you assume that we realize the benefits of SG&A that we're expecting – you would anticipate EBITDA is also a significant, you know, contributor to sort of that migration to free cash flow positive.
spk03: Great. Thanks. And I'm not sure if there's any color you can give us on the update on the divestiture process in relation to the merger, and then maybe just on the timing of how it would work out, say, you know, if you talk about a potential 2Q close, although I don't know if that's – something we're still sticking by at this point, but if it is, if, you know, how long would it take for you to, like, announce it and then for the review process to happen in order to meet that kind of a deadline?
spk04: Look, I think, as Charlie said on the call, the CRESCO call, you know, there's a path to closing the transaction. We've, you know, sort of jointly agreed to extend the outside date to the end of June There is significant interest in the assets that are up for sale right now, and we're sticking with the timelines that are in the public domain. But I think that the most important message that we can convey to the market is that, candidly, the way the stock is traded is a little bit shocking, and it's to the downside. I don't think we're getting any credit for having as strong a business as we have. And I think that what I would like people to take away from this call is a very simple message, which is the business itself is very attractive. The business itself is doing everything that it should be doing. And the team, you know, we've shown great continuity. And that ought to be, you know, that ought to be a sort of a catalyst for looking at where we are from a stock perspective. But, you know, independent of that, we continue to move forward with the transaction as contemplated.
spk03: Okay, thanks.
spk00: Thank you. Our next question comes from Matt Bottomley with Canaccord Genuity. Your line is open.
spk09: Yeah, thanks. Good morning, everyone. Just sticking on the transaction with Cresco, I'm just wondering, I know you can't get into any granular details on it, but are you able to provide any colour as to where private sector valuations are relative to maybe your expectations when this deal was announced? And just even... you know, the attractive nature of Florida and Ohio and some of these assets that are up for sale. You know, what is the landscape looking like right now just with respect to the capitalization of a potential buyer, you know, having the capital to potentially pull the trigger on it? You know, it's something that, you know, as everyone kind of follows the public market equities and, you know, how much they've sort of been eroding as of late, you know, getting a lot of inbounds and concerns as to, you know, how that's telegraphing to potential buyers for these assets.
spk04: So, I mean, I think the way I would – let me break that into a couple of different components. There is no shortage of capital out there for the sector. I think there's a shortage of willingness to deploy that capital, right? I mean, a lot of the assets that we're selling right now have some pretty significant regulatory sort of, you know, pathways that need to be understood in order to move forward, and that requires a lot of diligence. I mean, New York, Ohio, both of those markets could be dramatically different in 12 to 24 months, you know, just as examples. So we haven't seen a shortage of interest in getting into the sector. And frankly, I've been surprised at the upside at the number of parties that are not familiar with cannabis that have expressed interest in these assets because of the quality of them. But the timelines make it very difficult because you have several layers of things that have to go right at exactly the same time. And I think that's one of the things that has created you know, it's created an element of unpredictability in the asset sales that is just something that's hard to deny. The valuations, I mean, clearly there's a connection between valuations in the public markets and valuations in the private sector. I think, though, that a lot of the euphoria, first of all, a lot of the public sector investors that were in the sector that have cycled out may have been looking for catalysts that didn't materialize. So, for example, safe passing. And I think that was a real concern for people. And I think a lot of our competitors had done Done a lot to sort of build an expectation that that was a possibility when that didn't materialize right that that was a disappointment And so you saw people flow out wondering when the next catalyst is going to come but I think that the sort of the people that we're seeing now are much more fundamentally oriented and They're not they're not making their investment based on a catalyst they're making investment based on status quo and when you look at our business just as a microcosm for the rest of the sector right the amount of sg&a we've taken out of the the organization gives us a very clear path on margin improvement, EBITDA margin improvement, right? If we can even execute on half of the opportunities we see on the gross margin side, that flows through, you know, basically using the inverse multiple or the inverse margin, you know, as it flows through to EBITDA, right? That creates, you know, significant scale. So even with all the hiccups that come with cannabis, there are businesses out there like ours that have very attractive stories. And so I think that what we need to do as an industry, and frankly, we need to work with voices like yours, is to remind people that the fundamentals and the actual business outlook for the sector is very attractive. That hasn't changed, right? And I think that's one of the things that sort of contributed to all the, let's call it the noise that you're hearing in cannabis and the noise you felt through the capital markets. But, you know, does that mean that we're going to hit our sort of expected target for valuations of the assets being sold? I will tell. It's impossible for me to answer that question until we actually have the signed definitive agreements. But I'm encouraged by the fact that we have sort of agreements being negotiated. We have LOIs that are signed. We have parties that are very credible that are going through the process and very excited about the opportunities that an acquisition like that could mean to them.
spk09: Got it. Appreciate that. And then just one more for me. Just on New Jersey, I'm wondering is there any – dynamics that you can share with respect to, you know, future capex that's needed in that market? Call it in, you know, this year and maybe early 2024 in order to facilitate, you know, the growth profile that we've been seeing in that market or just to kind of, you know, jockey up positioning with where you guys are in branded sales or is it just more of a function of overall timing and ramp as opposed to needing to invest capital in that state?
spk04: So let me start off and then I'll turn it over to Derek and to David. To maintain the ramp of growth that we see today and that we've seen up until this point, we have the infrastructure that we need. We have significant – we've made significant capex on the cultivation and manufacturing side. There may be a few smaller things that we want to add here and there to sort of refine the portfolio and roll out additional concentrate lines or things in that kind of – in that sphere. But I think the biggest capex sort of piece would be completing that third dispensary and actually competing, you know, on a sort of apples to apples basis with others that have three dispensaries open, that would be very, very meaningful to us. But that's all upside. And so, you know, do we have the money for that? Yeah, we do. You know, do we have two sites in mind that we're looking at right now that are very serious? Yes. Has one of them, have we begun sort of picks and shovels and throwing hammers around in one of them? Yep, we certainly have. And so we're, we have, I think, the ability to accelerate that growth rate in New Jersey. But I don't think there's anything fundamentally necessary for us to compete in the wholesale and the retail setting that is sort of missing from the puzzle at this point. But David and Derek, maybe you guys can weigh in.
spk02: The only thing I would add is the significant capex investment required in New Jersey has been made by us. And so the incremental cultivation capacity is there for us. It's simply turning on lights and putting plants under them when we think the market opportunity presents itself. So We continue to aggressively commercialize ourselves in the state of New Jersey, primarily in the wholesale front. We have great organic growth at the dispensary level with the two that we have, but clearly the wholesale opportunity is large for us on a relative basis to the retail side. So continue to lean into it, and we have the capacity and can lean into it when it's appropriate. We've purpose-built those assets in New Jersey for a large adult use program.
spk03: Got it.
spk05: I agree, Ed. New Jersey is one of those great examples where we invested early and heavily, and particularly with the acquisition of the second cultivation site. We've got excess space at that second cultivation site ready for further expansion if needed. And as Nick said, it's the additional dispensary that will be the key part of any spending in 2023. Got it. Appreciate all those comments.
spk00: Thank you. Our next question comes from Matt McGinley with Needham. Your line is open.
spk07: Thank you. I have a few questions around the $35 million in annual savings. I think you noted that you don't expect to see the financials or that to show up in the financials until the end of the second quarter. So is the full year cost savings more like $17 million for the full year? How much of the savings do you expect to see in COGS versus SG&A? And with what you noted on the overhead absorption, I assume that a portion of that $35 million in savings is just related to having less labor in a mothballed production facility. But if you have this new offsetting absorption of fixed costs immediately that goes through COGS, is that $35 million run rate actually a $35 million run rate because you have this offset?
spk05: Yeah, so let me unpack a few pieces of that and appreciate the question. So the $35 million is a net cost. annualized savings and yes it was initiated in q4 so some of those savings based on canopy reductions and exit of the California ETLA site for example are a full year impact for 2023 there are additional canopy reductions that took place over time so there's not a full year impact but all of the all the restructuring it has been initiated in and at this point has now been executed on, so we've got the full benefit of that starting in Q1 and for the balance of the year. In terms of the overhead reduction, the SG&A reduction with 25% of our corporate overhead, corporate headcount, I should say, that was also initiated in late 2022, early 2023, and those individuals have left the company, so we've also got the the benefit of most of the year's impact on those savings. So you'll start seeing that benefit in Q1 as well.
spk01: What was the rough split between COGS and G&A in terms of savings?
spk05: I'm not sure we've done that split, but we can We can come back to you if we need to on that.
spk04: I think that the point you made about it being net savings, meaning that we factor that into our analysis to come up with this $35 million number. And the vast majority of it is headcount reductions through SG&A and basically the elimination of facilities or assets or operations that we're losing money. So, you know, I think, Matt, if I'm not mistaken, the question you're asking is, is it really a $35 million or is it substantially less because of the offset? I think what you're hearing us say is that it's a $35 million number. We've thought through that piece. It's still a moving target, but it's more than just – it's heavily weighted towards SG&A, and it's heavily weighted towards the removal and closure of non-performing assets. Is that a fair way to characterize it? Yep.
spk07: That's clear and that's helpful. And then my last question would be, when we get your full cash flow statement, when you file the 10K, what will be the big drivers of that improvement in working capital? Was that mostly deferred taxes or did you make progress in reducing inventory, which would likely be a little bit more sticky and say a lot more about your ability to generate cash from working capital in 2023?
spk05: Yes, so Q4, as you're pointing out, we had a $5.2 million of operating positive cash flow in Q4. There's some of the working capital benefits that we already saw as a result of some of the restructuring initiatives. Again, we announced in mid-January, but that was announcing at the end of the restructuring program. So there are some inventory benefits that we'll see and working capital benefits that will impact Q4. But it is an ongoing focus on liquidity and cash management that, again, we started in early 2022, given this was the third round of restructuring. So we're getting the benefit of multiple initiatives that are taking hold. Our deferred tax hasn't changed. No, we're current on taxes. There's no deferral of taxes that you're going to see as a result of that working capital. It's operationally focused.
spk06: Okay. Thank you.
spk00: Thank you. There are no further questions. I'd like to turn the call back over to Nicholas Vita for closing remarks.
spk04: Great. Well, thank you, everybody, for your time. I'm sure we'll be speaking with many of you throughout the day. If anyone has any follow-up questions, please let us know. We want to make ourselves available, and we'd love to reengage with you and tell you a little bit about all the great things that are happening at Columbia Care. Thank you.
spk00: You may now disconnect. Everyone, have a great day.
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