Cresco Labs Inc

Hello everyone and thank you for joining the Cresco Labs fourth quarter 2021 earnings conference call. My name is Gemma and I'll be the operator for today. If you would like to ask a question for the Q&A portion of today's call, please press star followed by one. If you change your mind, it's star followed by two. In addition to the Cresco management team, co-founder and CEO of Columbia Care, Nicholas Vita, will be on the line too for the live Q&A.

We shall now begin, thank you. Thank you.

Good morning and welcome to Cresco Labs' fourth quarter and full year 2021 earnings conference call. During today's call, we will also discuss the company's proposed acquisition of ColumbiaCare, which was announced this morning. On the call today, we have Chief Executive Officer and Co-Founder, Charlie Bechtel, Chief Financial Officer, Dennis Oles, and Chief Commercial Officer, Greg Butler, who will be available for Q&A. Prior to this call, we issued our fourth quarter and full year 2021 earnings press release, which has been filed on CDAR and is available on our investor relations website. These unaudited preliminary results for fourth quarter and full year 2021 are provided prior to the completion of all internal and external review and therefore are subject to adjustments until the filing of the company's annual financial statements. We plan to file our corresponding financial statements and MD&A for the three and 12 months ended December 31st, 2021, on CDAR and EDGAR later this week. Along with our earnings release, a press release, and investor presentation regarding the proposed acquisition of ColumbiaCare are available on our investor relations website. Certain statements made on today's call may contain forward-looking information within the meaning of applicable Canadian securities legislation, as well as forward-looking statements within the meaning of the United States private Securities Litigation Reform Act of 1995. The forward-looking information and statements may include estimates, projections, goals, forecasts, or assumptions that are based on current expectations and are not representative of historical facts or information. Such forward-looking information and statements represent the company's beliefs regarding future events, plans, or objectives which are inherently uncertain and are subject to a number of risks and uncertainties that may cause are actual results or performance to differ materially from such forward-looking statements, including economic conditions, changes in applicable regulations, the possibility that the expected synergies and value creation from the proposed acquisition will not be realized or will not be realized within the expected time period, the risk that the businesses will not be integrated successfully, disruptions from the acquisition making it more difficult to maintain business and operational relationships, and the possibility that the acquisition does not close, including but not limited to, due to the failure to satisfy the closing conditions, including the receipt of requisite regulatory approvals. Additional information regarding the material factors and assumptions forming the basis of our forward-looking statements and risk factors can be found in our earnings press release and in CRESCO lab's filings with CDAR and the Securities and Exchange Commission. Cresco Labs does not undertake any duty to publicly announce the results of any revisions to its forward-looking statements or to update or supplement any information provided on today's call. Please note that all financial information on today's call is presented in U.S. dollars and interim financial information is unaudited. In addition to today's conference call, Cresco Labs will refer to certain non-GAAP financial measures such as adjusted EBITDA and adjusted gross margins which do not have any standardized meaning prescribed by GAAP. Please refer to our earnings press release for calculation of these measures and a reconciliation to the most directly comparable measures calculated and presented in accordance with GAAP. These non-GAAP financial measures should not be considered superior to or as a substitute for or as an alternative to and should only be considered in conjunction with the GAAP financial measures presented in our financial statements. With that, I'll turn it over to Charlie.

Good morning, everybody, and thank you for joining us on today's call. It's a very exciting morning. We're pleased to share our Q4 and full year 2021 results, as well as our truly transformative news, the proposed acquisition of Columbia Care. Q4 marked the completion of a fantastic year for Cresco Labs. We produced $822 million in annual revenue, representing 73% year-over-year growth, and we maintained our position as the number one wholesaler of branded cannabis products as well as having the highest per store revenue of any scaled national retailer. While Q4 came in below our expectations, which Dennis will discuss in greater detail, we believe these results were more market driven than operational. In fact, we competed extremely well during the quarter, holding or gaining market share in seven of the 10 states in which we operate. In other words, we took everything that our markets were willing to give in Q4. A giant thank you goes out to the entire Cresco family for accomplishing what it did in the headwinds of the quarter. Operationally, Cresco Labs continues to execute regardless of the macro environment with a clear and focused strategy of building the most strategic geographic footprint and obtaining market leadership positions. As a cultivator, we're generating quality, potency, and consistency at an unprecedented scale. As a wholesaler, we're delivering the best-selling portfolio of branded products, driving traffic for our retail customers and delighting end consumers. And as a retailer, our highly efficient retail platform meets consumers where they want to be met, feeds back essential data, and supports our wholesale channel. The combination of these efforts has afforded Cresco Labs the ability to go deeper than any other operator in the markets that matter. This brings me to our other incredibly exciting news this morning, the proposed acquisition of ColumbiaCare. This acquisition will combine an amazing footprint with proven brand, operational, and competitive excellence to create a new leader in cannabis. On a pro forma basis, after planned divestitures, the combined company will be the largest cannabis company in the world by revenue, the number one wholesaler of branded cannabis products, and we'll have the largest nationwide retail network outside of Florida and number two overall. That is before we start sharing our brand portfolio, cultivation and retail operating procedures, or integrate into a unified data analytics and R&D team. Put simply, we believe the combined footprint and operational capabilities will lead to so much more than either company could achieve individually. The whole will be more than the sum of its parts. Now let's review three specific ways the acquisition of ColumbiaCare is synergistic and will lead to attractive, sustainable financial performance, superior market access, proven capabilities in wholesale and retail, and balanced economics. Number one, superior market access. The proposed acquisition of ColumbiaCare adds eight new markets to Cresco Labs, including the high-priority states of New Jersey and Virginia, and provides depth, vertical integration, or the opportunity for asset optimization in nine more. Combined, our footprint will encompass 17 states and Washington, D.C., covering 180 million Americans, or 55% of the total U.S. population, and over 70% of the addressable cannabis market. Our pro forma footprint is expected to be a $31 billion total addressable market by 2025, according to BDSA. The combined company will have a presence in every important cannabis market, including the industry's mature influential markets, today's material markets, and tomorrow's high growth markets. Cresco Labs will have operations in all 10 of the industry's top 10 revenue states in 2025 per BDSA. And importantly, we aren't just talking about breadth, we're talking about depth. Currently, the combined companies have the number one share position in four markets, Illinois, Pennsylvania, Colorado, and Virginia, and Cresco Labs is number two in Massachusetts. Upon closing of the acquisition, we believe we have a pathway to top three positions in New Jersey, New York, and Florida, which would give us material market positions in seven of BDSA's top 10 markets by revenue in 2025. This level of depth and breadth in the largest markets is unrivaled, and we believe it'll provide us with not only economies of scale leading to superior margins, but also meaningful brand equity and long-term competitive moats. The acquisition is expected to expand Cresco Labs growth tailwinds for the foreseeable future. Looking at the expected adult use catalyst in the next few years, we will add one of the operational vertical licenses in New Jersey, two of the four licenses in Virginia, and we'll have optionality with two of the 10 licenses in New York. Additionally, we anticipate expanding on our number one share position in Pennsylvania with the addition of three retail stores, optimizing our maxed out footprint in Ohio, and doubling our existing retail network in Florida. We believe Cresco Labs is well positioned to capitalize on every meaningful adult use catalyst for the foreseeable future, driving growth well above industry average. The transaction isn't just about new states. It also improves our depth in existing states. For example, ColumbiaCare will add cultivation and retail in Maryland, allowing us to get fully vertical and improve margins ahead of adult use conversion. Additionally, it adds retail in California, once again, increasing our effectiveness through the benefits of vertical integration, and will add highly productive retail in Arizona, where we have been underscaled. The acquisition would effectively address three markets that are currently operating below our average gross margins. and would give us vertical production and retail operations in every market except Michigan. When looking at the optimal way to round our footprint with material positions in the most important markets, we believe ColumbiaCare is the most synergistic fit. They've assembled a fantastic footprint full of high quality assets with established infrastructures and experienced operating teams. The acquisition is expected to address all of our material potential gaps And the few overlaps where we have to divest licenses and assets are in highly sought after valuable states where we should be able to generate significant proceeds from the sales to fund future CapEx and or de-lever the organization. Number two, proven capabilities in wholesale and retail being leveraged across a wider footprint. In 2021, on a much smaller state footprint than some of our peers, Cresco Labs was the number one seller of branded cannabis according to independently published data from BDSA. Running through some of the stats, we are the number one company in the branded flower category, number one company in the vape category, number one company in the concentrates category, and have a top five position in the edibles category. Collectively, Cresco Labs has the number one selling portfolio of cannabis products in the industry. The ability to leverage our cultivation, production, and brand performance across a much wider footprint is expected to lead to long-term sustainable growth and market share gain. Over the longer term, having our products, which have proven their popularity and will now be available to 70-plus percent of the addressable market, is what we believe will turn our tiered brand portfolio of High Supply, Cresco, and Florical into the Miller High Life, Coca-Cola, and Johnny Walker Blue label of the cannabis industry. We're creating mainstream brands that command significant share of shelf, have personal and cultural relevance, and are easily accessible to the majority of the addressable market. The opportunity isn't just with our product brands, but also with our Sunnyside retail banner. Throughout 2021, Cresco Labs has had the most productive stores of any scaled MSO. We consistently take above fair share of market sales. In Illinois, for instance, We index it over one and a half times our fair share. This is largely a function of our product assortment, retail experience, and throughput. We have a history of increasing productivity at acquired retail. With our Verdant acquisition in Ohio, we saw 57% improvement in the nine months post-systems integration and rebranding to Sunnyside and have seen similar results in productivity improvement with other acquired stores. This is an opportunity for us to expand our operating procedures in Sunnyside Banner and across an additional 80 plus stores and eight new states, creating the second largest cannabis retailer in the industry and the largest retail footprint outside of Florida. We are a CPG-focused company, and adding additional retail furthers our ability to connect directly with consumers and build our brand equity. We believe the combination of Cresco and ColumbiaCare will accelerate our mission to be the undisputed leader in cannabis CPG in a way that no other potential M&A could. Number three, balancing economic drivers and driving sustainable financial results. The combination is expected to significantly diversify our economic drivers, giving us a more balanced state revenue mix, along with an increased percentage of revenue from retail. In 2023, with this combined platform, we expect to have eight markets generating over $100 million each in annual revenue. This breadth of contributing states significantly de-risks our revenue profile, making us the most diversified operator in the industry and capable of managing the dynamic nature of state by state operations. The higher percentage of retail revenue will give us more consistent timing of sales and should provide us with greater predictability in forecasting revenue. While the future still favors the middle two verticals of the value chain, the benefits of channel balance are particularly important during this building period. I've already touched on how increased scale and vertical integration will improve margins and enhance the opportunity to drive long-term synergies, cost savings, and profitability. From the lowest hanging fruit like public market costs to longer-term synergies like HR, data analytics, finance, and other shared services, there's an opportunity for meaningful cost reduction to provide consumers with more affordable cannabis, bringing more consumers into the regulated market. Likewise, we see an opportunity to have material savings on duplicative CapEx projects and realize value from the sale of redundant licenses and assets to pay down debt, positively impacting the free cash flow profile. Looking ahead, we're cognizant of the risks inherent in a deal of this size, but feel confident in our team. We've built strong muscles here, integrating five companies, over 600 employees across 24 sites in 2021. That is bringing infrastructure, operating procedures, reporting, data, and decision-making onto a standard platform, all while maintaining strong cost control. And after getting to know Nick and some of the ColumbiaCare team, we look forward to repeating this with ColumbiaCare, bringing the best from both organizations to the forefront. Again, this acquisition will combine two of the leading MSOs, pairing an amazing footprint with proven operational brand and competitive excellence to create a true leader in cannabis because it also combines the highest revenue cannabis company in the world that is also the industry's leader on matters of social impact, the most popular brand portfolio in the industry, and the most strategic geographic footprint representing influence, size, and growth, and the most productive retailer and the largest nationwide retail store network outside of Florida. all tuned to addressing the needs of our stakeholders. More opportunities for our collective team members, better and more affordable cannabis for consumers, responsible cannabis for regulators in our communities, and increased cash flow for our shareholders. With that, I'll turn it over to Dennis to discuss Q4 results.

Thank you, Charlie, and good morning, everyone. I'll begin by reviewing the financial results from the quarter, then highlight a few items from the balance sheet and discuss our capital position. I'll close with a quick touch on the deal terms and the expected timeline before passing it back to Charlie for closing remarks. Turning to our results, our fourth quarter revenue was $218 million. As already noted by several of our peers, the quarter saw some unique and unexpected market events that resulted in lower than expected revenue. In October, we made a strategic decision to significantly reduce our third party distribution business in California that fundamentally changed our business in that state. At the same time, the market experienced a 6% sequential decline in demand, coupled with an approximate 25% drop in the weighted average cost per pound. These events created a challenging quarter for all operators in the state, and impacted pricing as we sold through our remaining third-party inventory. Setting aside California, the rest of our platform had 6% sequential growth outpacing the overall market. In Massachusetts, we saw a softening in demand in December that the market had not previously seen. With our recently closed acquisition in the state, We anticipated a substantial portion of the quarterly revenue coming in the last two weeks of the quarter as it had historically. Those sales didn't materialize because the market couldn't support that volume in December. But again, we competed incredibly well. We held our group share in the majority of our markets, including the markets just mentioned, and we achieved the number two market share in Massachusetts for the quarter. As Charlie stated previously, we got everything from our markets that they were willing to give us in Q4. Q4 revenue mix was 46% wholesale and 54% retail. Retail performance was particularly strong, up almost 10% sequentially and over 60% year-over-year, driven by store growth in Massachusetts, Florida, and Pennsylvania at the end of the quarter. Same store sales improved 28% year over year. Overall, wholesale revenue declined 7% sequentially, materially stemming from our exit of third-party brand distribution in California. Excluding California, wholesale was up 2% sequentially. For the full year, wholesale revenue was up 12%. Across the rest of our footprint, we had some notable wins during the quarter. In Pennsylvania, we took market share on the back of improving flower quality as enhancements we made in the operating procedures early in the year started to play out. In California, Floracel was the number five selling flower brand in the state during Q4 and has moved up to number four in January. Going forward, in California, we won't see the same headwind in 2022 as we have substantially sold through our third party inventory that we held at the end of Q3. In Massachusetts, we're making good progress on the integration of Cultivate and the alignment of our brand portfolio. Fourth quarter gross margin excluding the fair value of markup of acquired inventory was $118 million or 54.4%. An improvement from 54.2% in Q3, our fifth quarter in a row of improvements in gross margin. Over the course of the year, we've seen an over 800 basis point improvement driven by achieving operational scale in more markets The strategic decision to shift away from third party brands in California and our entry into the vertically integrated high margin Florida market. Looking ahead, our goal is to maintain gross margins above 50%. We will continue to see improvements from the investments we are making today in automation for processing and packaging, along with increased cultivation yields. However, this will in part be offset by price compression. While inflation is making other consumer goods more expensive, we have the opportunity to provide more value to our consumers, convert more people from the illicit market, and unlock industry growth. As a leader in this industry, it is on us to continue to optimize our operations through automation and scale to drive down costs and provide a quality, consistent, and affordable product to our consumers. Fourth quarter SG&A expense excluding share-based compensation and non-core items was $65.6 million, or 30% of revenue. We held SG&A dollars constant for the past three quarters despite adding 22 dispensaries, integrating four new acquisitions, and adding over 1,000 employees. While we will continue to make investments in our people, processes, and systems this year, we expect to see continued leverage in our SG&A expense relative to sales for the full year. Adjusted EBITDA for the fourth quarter was $57 million, representing a margin of 26%. While this did not hit our 30% goal, we maintained the improvement in margin we delivered in Q3 as we continued to demonstrate our prudent cost management and ability to create operating leverage in the face of increased market pressures. We generated $37 million in operating cash flow during Q4. Even adjusting for changes in working capital, we've seen significant improvement in operating cash flow over the course of the year and improvement in our conversion of adjusted EBITDA to operating cash flow. Put another way, we've continued to improve at converting a dollar in revenue to a dollar of cash flow that we can turn around and invest in the business. This will be a key focus for us in 2022. Fourth quarter gross CapEx was approximately $17 million, bringing our full year gross CapEx to $94 million. We finished the quarter with $226 million in cash. Our net debt to EBITDA ratio is 1.7 times within our targeted range, and we feel good about our capital position today. Looking ahead, on the retail side, we have new dispensary openings planned in Florida and Pennsylvania throughout the year to expand access to our products and drive share gains. In Florida, we just announced the launch of disposable vapes and gummies for the first time, a key unlock as we look to give patients a better value proposition and selection when deciding which dispensary to visit. On the wholesale side, we will be rolling out our FluorCal brand across multiple markets throughout the year to play at the ultra-premium category in flour, vape, and concentrates. Our approach to tiered pricing has allowed us to meet consumers where they want to shop while maintaining margins. Having said that, the start of the year has seen a tough macro environment. Based on BDSA data, our markets are down mid single digits compared to the first two months of Q4 in the face of higher inflation stretching the consumer wallet, staffing and consumer access to issues due to Omicron, and traditional seasonality. As such, and consistent with what you've heard from other MSOs, we expect growth to be relatively muted to flat in the first half of 2022. Notwithstanding, we'll continue to keep our heads down, keep executing on the business, and keep putting the pieces in place to ensure the successful integration of ColumbiaCare and achieve industry leadership for years to come. Now turning to the ColumbiaCare announcement, this acquisition is accretive based on 2023 sales and expected adjusted EBITDA projections. We believe, and so does the ColumbiaCare board and management, that there is greater opportunity for multiple expansion and upside for our shareholders together as a combined company has better growth prospects, more scale, greater economic diversification, and lower risk. We intend to de-lever the combined company's capital position by allocating a portion of the proceeds from the required divestitures to repay existing debt. The areas where we will likely divest assets happen to be the most sought after and valuable markets in cannabis, New York Illinois, Ohio, Massachusetts, and Florida. More to come on this in the coming quarters. Over the next couple of months, we will be working closely with the various regulators and should be in a better position to update you on the expected closing timeline by our Q1 conference call, but expect it to be around year end or Q1 of 2023. I'll pass it back to Charlie for some closing comments.

Thank you, Dennis. Our teams are incredibly excited about what lies ahead for Cresco Labs and ColumbiaCare shareholders. This is the convergence of two companies with a shared vision for what a normalized and professionalized cannabis industry should look like. We're pairing the best consumer brands with the most strategic, deepest, and highest growth footprint. That combined with proven operating expertise should drive growth and increase shareholder value for years to come while Cresco Labs achieves its vision of being the most important,

impactful company in cannabis with that I'll open the call for questions thank you and as a reminder if you would like to ask a question please press star followed by one in a telephone keypad and if you do change your mind it's star followed by two Our first question today comes from Owen Bennett of Jefferies. Owen, your line is now open. Please go ahead with your question.

Morning all and congrats on the deal. A couple of questions, please. First of all, I just wanted to get your thinking around how you are thinking around the combined brand portfolio and which specific brands from Columbia Care would fill any specific gaps in your portfolio.

then the follow-up would be could you just comment on any states where you may have to make some divestments for this deal to go through thank you good morning owen thanks for the questions um yeah so as it relates to the combined brand portfolio i think that's one of those the things that we're going to be working on and develop um you know between now and the closing of the transaction they've got some good brands over there that may fit very nicely in our portfolio, vice versa. You know, states matter and the state consumer profile matter. So one of the things that we'll be working on as we go forward. And as it relates to state divestiture, yeah, there's going to be some states, as we talked about in our prepared remarks, because of licensing caps, that will need to evaluate divestitures. We think it's a great opportunity for us to optimize operations in those states, and then clearly, you know, proceeds from any divestitures can be very productive in future CapEx needs and also delivering the business. So we think it's a great opportunity. I'd also mention those states, you know, as Dennis mentioned, are very sought after and valuable states. So it's a great thing we'll be working on over the next nine plus months here.

Okay, great. Thanks again.

Thanks, Owen.

Thank you. Camila Lyon of BTIG, you have the next question. Please go ahead.

Thank you, and good morning, everyone, and Charlie, and congrats on the transaction. I, too, wanted to follow up on the thinking around particular state divestitures, specifically New York. Charlie, I think you just got approval for your facility. Um, and Columbia care has, has, uh, uh, an up and running greenhouse, um, in stores. So could you help us think about what way you're leaning in terms of which, which portion of the assets you're going to keep versus sell? Um, would you, would you build up that facility that you just secured for Cresco? Um, or will you divest that portion of the business? Um, and then just from a higher level perspective, kind of the rough math that we're, you know, kind of ballparking in terms of the potential gains that you'll make on selling the overlapping licenses and the vestitures you spoke of, kind of getting to a range of, you know, $250 to $400 million. Is that around what you're thinking based on some of the work that you've done already in terms of the overlapping nature of the states? Thank you.

Sure. Good morning, Camilo. And I'll start this off, and then I'll also invite Nick to chime in on this, too. You know, New York is one of the more interesting states because we do have overlap there. That would give us two of the ten. And we both have certain stages of development in production facilities. We both have retail footprints. So I think that's going to be a project and a process where we think about the optimization. There's a lot more that goes into that analysis than just square footage or building type. It's also, you know, logistics. There's all kinds of factors that play in what area, what location of the state we would want to commit to. And then also, to your point, the end divester value as it relates to that. But I would ask Nick if he'd like to contribute his thoughts there, too.

Thanks, Charlie. You know, Camilla, one of the things that I've been so impressed by as we've gone through this process, you know, this discovery process, understanding one another's organizations, is that we really do have a laser focus on driving shareholder value. And as we looked out in the landscape in the future and we thought about things like deleveraging, use of proceeds, asset sales, we're in a very fortunate position because every one of the markets that we might consider a divestiture are incredibly sought after. So these are not kind of afterthought markets. These are primary markets that other operators that don't have exposure to them must have in order to compete effectively and frankly, in order to be considered a market participant, a viable market participant. So I think that amount of that sort of reality of what we're looking at makes this a very unique moment in time for us to jointly look at the landscape on how we optimize shareholder value and frankly how we prioritize which assets are sold. There is no pride in authorship, meaning we are both incredibly impressed by one another's teams and organizations. And for those colleagues who are listening to this call, I would just say whatever the decision might lead to, it will be done in a very thoughtful and deliberate way so that the integrity and the purpose and the mission of what you all have built remains intact going forward. And in the process, I think our shareholders will really be the beneficiaries. In fact, their debt holders are likely to be beneficiaries as well. So I don't think we need to talk about sort of expectations for pricing yet. other than the fact that these are arguably the most attractive markets in the U.S. market, which is obviously the market that people need to be in to be considered market leaders.

Understood. And if I could just ask more of a more broader question with respect to the integration. How are you considering the team that will be charged with integrating a pretty heavy list? in all fairness, right? This is an incredibly exciting transaction, but definitely one that doesn't come without its share of work. So maybe if you could just help provide some clarity in terms of how the responsibilities of running the day-to-day operations will unfold as it relates and as it compares to those that will be charged with making sure that the integration unfolds to the level that everybody wants it to happen at.

Sure. You know, I mean, this is, fortunately for us, this, as I mentioned in my remarks, this is a muscle that we've developed over the past couple years, but definitely over the last 12 months. We closed on five different M&A transactions, fully integrated those organizations. And, you know, when we integrate acquisitions, it's full integration, right? So it's the transferring and the bringing on of every element of that onto our platform. So Fortunately, we've developed capabilities here. We've developed teams. We've developed experience. But not to be short-sighted to your point, this is big. And so this is going to be something that we focus on getting right because it's very important for all the reasons that have been discussed so far. So we'll also include third-party professionals and resources to make sure that we can manage through the bandwidth while we lead it.

Charlie, may I add something to that? Great. Thanks for that and all the best.

Oh, sure.

So one thing to keep in mind is that Charlie and I are both co-founders of our organizations. So you're talking to the people who had a vision for the way a company develops from the very beginning that has basically been continuous and has had a very high degree of continuity since day one. That fundamental kind of connective tissue, I think, is what has allowed Cresco and ColumbiaCare to make acquisitions and successfully integrate them We've obviously through the due diligence process thought through a lot have begun thinking to a lot of these issues But just to reiterate what Charlie said the human capital element and the cultural element which often lead are the two Sort of most significant risk factors when integrating a business are actually the two areas that I think were most were most important when we thought about combining in the first place meaning a if we didn't have cultures that fit so well together, right, the organizational design would be a much more complicated process. And if we didn't have the skills on either side to recognize what our relative strengths and weaknesses were, then, again, I think we would run into probably more problems. But the benefit here is that both of these organizations, I think, have really done a good job of finding a way to build the internal capability to sort of manage that process And we'll be doing it on a parallel path, and we'll be doing it together once the close takes place.

Sounds great. Good luck, and thanks very much for the answers.

Thanks, Camilla.

Our next question on the line comes from Vivian Aza of Karen. Please go ahead, Vivian. Your line is now open. Thank you.

Thank you. Good morning. So, Charlie, obviously the wholesale backdrop was challenging in the quarter, but your business model had been focused on that channel as a longer-term way to establish a true CPG-like portfolio in a geographically focused way. So with a pivot to a bigger retail mix with this proposed transaction, can you comment on your medium-term outlook for wholesale pricing broadly beyond the softness in the first half of 22 that was discussed during the prepared remark? Because to us, this deal would suggest that you expect continued volatility at a minimum of and more probably sustained downward pricing pressure. So I was hoping you could quantify that. Thanks, and I have a follow-up.

Good morning, Vivian. Thanks for the question. You know, I think as we articulated, one of the things that we really liked about this deal is more balanced economics that we're going to get through the organization. And that was both as it relates to states where we'll have a more diversified revenue profile from the states that contribute to our overall P&L, which we love, right? Less concentration in two, three big states, but as we mentioned, eight states contributing over $100 million in revenue in 2023. So that's great. The other thing too is more channel balance. And as we've always talked about, our thesis, our core thesis always has been, still remains, the future of this is in the middle two verticals of the value chain, right? And that's brands and distribution of brands on as many shelves as possible. But in the interim, balanced sort of approach and verticality are key during this building phase. So we like the balance that this larger profile gives us. Plus, again, as you've seen, we've developed some strengths in becoming a retailer over the last couple years, too. And I know Greg has some additional thoughts here.

And just to build on that, I think your question, we do expect to see continued pressure on pricing and wholesale. That's something we are planning for. I think we're seeing it across our markets. But Because we plan for it, it's also why we have a very strong house of brands that enables us to play at different price points. And so what you're going to see for us focus is how do we ensure that we're competing at the low price points as price drives down, but also educating consumers on quality and value to ensure our higher price points of our premium brands that we are continuing to delight and own a superior pricing perspective. So in the combination with ColumbiaCare is only going to help strengthen our total portfolio brands.

Understood. That's helpful. And just a quick follow-up on capital allocation. So I definitely hear you on the cost savings around duplicative CapEx on cultivation. But did I understand correctly that you intend to rebrand ColumbiaCare's retail doors to Sunnyside? I mean, that's a little surprising to me, given that ColumbiaCare just made notable investments to harmonize their own retail banners.

You know, Vivian, this is Charlie. I'll take this one. You know, I think that's similar to the brand rationalization question earlier. I think we'll do the same thing there on the retail side. You know, of course, we love the Sunnyside brand. We think it's very effective, but we'll be looking at this over the next nine plus months from now till closing and even after to really develop a thoughtful strategy on a state-by-state basis as it relates to the branding of the retail flags.

Thank you.

Thank you.

Our next question on the line comes from Kenrick Tiger of Alta Corp Capital. Kenrick, your line is open. Please go ahead. Thank you very much.

Thank you. Good morning. Charlie, congrats on the deal. Great to see and congrats to the team and the team as well. Just coming back to New York quickly, if we could, we've spoken and appreciate the potential surfacing of value here from divestitures, but there's also some real dislocation risk if you can't quickly get to agreement on what the footprint needs to be or will be such that you can continue building it and maintain that paceable between now and let's call it end of year or early next year as we head into adult use in New York. How are you thinking about avoiding any dislocation risk in New York? How confident are you that you can and will be as ready as either of you would have been standalone, given the noise that some of the decisions here could potentially create in that equation.

Good morning, Kendrick. And, you know, a valid question. I think New York in particular, because those facilities are still in sort of production and build phase, and there will be a likely divestiture of one of them, I think both organizations are going to proceed doing what we need to do to make sure that those facilities are functional and operational in time to meet the adult use market. But keep in mind, everything that we do in furtherance of that we think also creates value for the divestiture. So it's one of those where I think we'll proceed, but it's not sort of a lost or sunk cost in that respect. It's something that's creating more value as we look to divest a certain asset.

Appreciate that, Charlie. And then maybe just switching to Florida briefly, one of your comments there was a path to a top three position in New York, New Jersey, and Florida. Just focusing on Florida, what do you and the team believe that the combined entity will give you in Florida that perhaps neither of you had a path to standalone given, I realize, very different footprints in those states, but you know, what's the secret sauce here on a combined basis that you believe gets you to that top three? Because Florida has certainly proven a more challenging market for the majority of players than was expected. So any additional color there would be great. Thank you.

Sure. You know what, Greg, you want to start with this one?

Sure. Good morning. I think your question of Florida, what's so exciting about this opportunity is it's going to give us access to more doors in the state, which only accelerates our plans. We have, we we've been on, Our cultivation and quality cultivation we have in our state is going to ensure that we are bringing to those stores quality flour, quality manufactured goods, which is only going to help us increase our baskets, average baskets across our legacy stores and then new stores. And so it does really give us an incredible footprint and one of the best assortments of quality brands in the state, which if you combine those two, it's the thesis on why we think that'll give us that guide path to a top three position.

Thanks so much, Greg. I'll get back to you. Thanks, Kendrick.

Matt McGinley of Needham.

You have the next question. Please go ahead.

Thank you. I can appreciate that you might not have all the answers on potential divestitures, but in a few states, it would seem like ColumbiaCare and Cresco would be going down a parallel path in terms of spending capex on assets that you might not hold onto. So can you discuss how this announcement would impact your combined CapEx plans into this year?

Good morning, Matt. Dennis is going to handle that.

Yeah, thanks, Matt, for the question. So we've obviously been in discussions quite a bit with the Columbia Care team. We understand what their capital plans were for the coming year in addition to our plan. So there is an opportunity to reduce some capital spend in markets that we plan to divest in. between the different companies, and we're managing that effectively. I think that is one of the synergies that we will recognize, not only in reducing the cap plans, but also capital avoidance in some of these larger sites where we may have had to make some large investments in Florida to build out our cultivation, and Columbia Care's assets will help us get that capacity and that biomass that we need without making a large investment.

Got it. And Dennis, on the gross margin side, the operational efficiencies would have had to been quite high in the fourth quarter to offset the gross margin pressure from price decline and the wholesale market weakness that you saw. Was there something unique about the production efficiency gains that you were able to achieve in the fourth quarter? And how much of the margin benefit to gross margin in the quarter did you get from restructuring of that California distribution business?

Yeah, certainly the restructuring of the California getting out of the third party distribution business was a benefit in Q4 relative to Q3. Now, we also did have some hangover inventory that we had to dispose of in the quarter. So that did put some additional pressures on that in California in the quarter that won't carry forward. But it's a combination of that and the additional increase that we saw in Florida. so which has got significantly higher margins than overall. So we're pleased with the margin performance that we had in the quarter. We think there's opportunities to build on that to offset some of the pressing pressures that we know is going to come in the markets going forward.

Thank you. Thank you, Matt.

The next question comes from Aaron Gray of Alliance Global. Please go ahead, Aaron.

Hi, good morning and congratulations on the deal. So first question for me on California. So it's been an important market for Cresco historically as well as for legacy ColumbiaCare. You commented on pricing pressure. So curious as to how you look at retail. Obviously now you'll get some retail from the announced acquisition of ColumbiaCare. I'm just curious beyond that, would you also look to get deeper on the retail side within California to potentially offset and get more vertical some of the pricing pressures you're seeing in the state, or just would love to see your overall views in terms of retail now within California beyond just the Columbia Care and asset acquisition? Thank you.

Good morning, Aaron. This is Charlie. So, yeah, you know, as we looked at sort of what will be absorbing and gaining in California. We really like the idea of the retail platform. So I guess our operations in that state, I would consider very complimentary. And one thing that we have learned and that we do prioritize is getting vertical, the value of getting vertical in every state that we're in. So again, it takes us from being just a wholesaler in California to now being vertical. I think it adds strength and stability in a market where we do have a sort of a soft spot there. So it definitely enhances our California operations. Greg, do you have additional color?

I think from a step one perspective, you know, the great opportunity for us is we know we have some great brands in California. Florical, for example, is just the top five brand in the market. So being able to take our brands and bring those into stores is a huge opportunity. We always look at retail cautiously, too. We know that in the second half of last year, I think cultivation licenses grew 10x retail. So that tells us there's a lot more supply coming online, which means price pressure is going to continue to come down, which means some of these retailers might be looking to exit that businesses are looking at their own pricing and what they have to do to compete, which gives us an opportunity to potentially pick up some complementary assets in phase two. But phase one is our winning brands into stores is a really exciting new step for us, and we'll take it from there.

Okay, great. Thank you very much. And then second question for me, as you guys are now getting more vertical in the different markets amid the pricing pressure, just thoughts in terms of, you talked about the brand rationalization, but also, you know, selling products, you know, within your own stores obviously creates more margin opportunity. So how do you kind of just pose, you know, the value in terms of having the different brands so you can kind of have different product offerings for the consumer while still being within your own, you know, portfolio to capture that margin? And maybe if you might have some target mix of what you'd like to have in terms of your own products, you know, that you're selling within your stores versus third-party brands, you know, for those states where you're going to have the wholesale opportunity. Thank you.

So, you know, it's a question we tend to get on these calls. Our view is we always want to have the best assortment in our stores possible. So that does mean we do have a bias towards our own brands, but we also want to ensure that we're bringing in third-party brands as well to really delight shoppers. historically our average of own brands to brands has anywhere between 40% plus I don't see that changing drastically as we continue our focus is clearly to your point we do tend to make and we do make significantly better margins with our own brands but as we think of trips and what drives customers to our stores assortment matters and so our focus will always be having that right mix of own brand, not own brand to maximize margins, but also an assortment that really drives customers into our stores. And that's been the key to our success today and will be the continued focus for us going forward.

Okay, thanks very much for the call, and I'll jump back in with you. Thanks, Aaron.

The next question on the line comes from Pablo Zuanic of Cantor Fitzgerald. Please go ahead. Thank you.

Pablo Zuanic Yeah, good morning and congratulations to both, everyone. Nick, just one question. I mean, over the last two, three weeks, many MSO executives were in DC lobbying senators, right, for safe banking reform and other things. And I understand there's been a lot of other bodies also lobbying for reform. And some people are to believe that SAFE could actually happen this year. So if you went to D.C. and you lobbied, and a lot of people are thinking that SAFE could happen this year, I'm surprised you would be doing this deal right now. I would have waited if SAFE is going to happen, because obviously you could have had more opportunities on the bid side. So any thoughts on that? Did your visits to D.C. or maybe you heard something different there and your interpretation was that SAFE won't happen for a while? So it's better to consolidate right now and do this merger. Thanks, Nick.

Sure. So I would bifurcate those two elements into different categories. I do think that there will be movement on the SAFE Act, and I think it'll be driven by Congress, not by the executive branch. I think there has been a significant amount of support expressed from Republicans as well as Democrats. I don't have any idea of the timing. Frankly, I've always been wrong when it comes to political prognostication, but it is going to happen. But I would actually turn the perspective a little bit on its side relative to the way you positioned it. By the way, we talked about this at the board level, and we talked about this as a management team, and we talked about this with Cresco. The reality is that the companies, the leading companies in the sector generally trade in parity with one another. We've always traded at a multiple discount, and I think that there's no harm in admitting the fact. But one of the theories and one of the theses that we've always sort of believed in deeply is that once SAFE passes, assuming it or something like it passes, and assuming that it gives institutional investors the ability to invest in cannabis, they're going to be looking for scale, they're going to be looking for credibility. They're going to be looking for best in class. Cresco, independent of ColumbiaCare, and ColumbiaCare, independent of Cresco, I think have built the best platforms in the sector. In terms of those three criteria, because remember, whether you're a strategic investor or an institutional investor, your priorities are different than if you're sort of an overnight investor or if you're just looking at things in a very narrow window. You have to look at it on a multi-year basis. And so for us to attract the type of institutional capital that will drive multiple expansion, that will drive strategic conversations, and that will actually be available to the market leaders once federal approval happens, this is the best way to position for that moment in time. And so our view is that, you know, is there a scenario that someone could come up with that would sort of somehow result in a bump in multiple to each company individually? Yes. But I think that together on a combined basis, the market leader will, as we've seen historically, will trade at a premium multiple. And so one of the elements of the thought process behind this combination is to achieve that multiple re-rating in the most durable manner possible. So there was no other combination that we could find and no other pathway that we could see that would allow us to position ourselves for that moment in time And I would argue you want to have the infrastructure and the combination sort of fully baked by the time you reach that point in time so that the investment thesis for institutional capital is not only well understood, but also de-risked because the integration is likely to be either in process or done at that point. So I actually think that you couldn't ask for a better moment in time for this kind of combination, specifically because we're starting to see real bipartisan and bicameral support for this type of legislative change. Charlie, I don't know if you have anything to add to that.

I think that was well articulated.

That's very helpful. Charlie, just one quick follow-up. You said likely divestiture in the case of New York. In the case of Florida, obviously, based on harvest and to leave, you can sell the paper license, but you can keep the stores and the cultivation. At least in some states, you have 100% visibility in terms of divestitures. In the case of New York, I would argue it's not so clear, right? There may be hemp licensees that are allowed to cultivate. There may be Native American tribes that are allowed to start cultivating and selling cannabis. So there is a scenario, and even the caps on cultivation for the incumbents are still, to my understanding, still being debated. So there's still a scenario where you could keep both of the facilities. What am I wrong about that?

You know, I think it's a fair recognition there of why I put the word likely in front of it. It's because these are dynamic situations, and those conversations, while preliminarily have been started with the regulators, of course, to notify them as soon as we could about this deal, those are conversations and structures and developments that will happen, again, during the period of time between now and closing. Because you're right. Anything is possible as it relates to regulatory requirements over the next nine months.

One last one, Charlie, if I can. If you look at the ColumbiaCare brand portfolio, which brands from the ColumbiaCare portfolio would be excited and rushing to start selling nationally through your network?

Greg, you want to handle that? Yeah, Pablo. You know, I think as we look at the portfolio, one of the reasons we have become the number one wholesaler brand is because of our portfolio approach of good, better, best, playing across segments. And that's why we've seen such success on brands like Cresco. On their portfolio, I think the way to answer that is we'll look at that over the next couple months as we continue to evaluate by state. where there are tuck-ins of opportunities and where our portfolio isn't reaching opportunities. So I'm not prepared to rule out any brand at this point. I think all of them will be investigated as we go and will probably be a unique-by-unique state assessment to see where we have these opportunities in that portfolio mix. Okay.

Thank you.

Thank you, Pablo.

Our final question today comes from Scott Fortune of Rolf Capital and Partners. Please go ahead. Thank you.

Yeah, good morning and thanks for the questions. You mentioned you gained share in PA on improved cultivation and how do you look at the cultivation synergies and efficiencies now on the operating side and improvement opportunities in the key states to offset the pricing pressures? Just kind of give us your thoughts around the you know, operation leverage on the cultivation side with this merger and the synergies and efficiencies improvements that you guys can garner from that going forward here?

Sure. Thanks for the question, Scott. You know, I think just at a high level and maybe the direct answer on this is, again, different organizations brought different things to this combination, right? And I think from the production and retail capabilities that we've established, We get to now bring that across the footprint and the infrastructure that ColumbiaCare is bringing to this deal. Very excited about those synergies, those improvements, those sort of internal catalysts that we can create by getting our SOPs and our capabilities across this big infrastructure and big footprint. So very excited about it. It's definitely one of the main drivers of value that you'll see from this combination.

Got it.

And then one more real quick, just focusing on the California market and what you're seeing currently there. Obviously, the pricing side, we've had a lot of supply coming on board. How do you look at the California market, seeing any trends to stabilizing pricing here? If you look at the 2022 and kind of expectations of a lot of M&A and consolidation going on on the California market, how can we view that going forward here?

Hey, so I think in California, as we look at it, the comment we made before, which I think is really interesting for us to take a look at the back half of last year, is that cultivation licenses created 2x retail doors in the state. And so that really is what's driving the volume of supply that's pushing price pressure in California. Because of that happening in the back half of last year, as you look to this year, we don't see in the near term any sort of relief on price compression. because of the volume of supply that's coming into the market. And I think that's going to be the continued story for California for the rest of the year. So what that means for us is it puts greater emphasis on the need for us to bring our portfolio into the market. It means we have to be able to compete with brands like High Supply on the low price, good value equation. But it also means that we continue to educate consumers on what makes our more premium brands like Florical special. to give them a reason as to why they're going to pay a premium relative to California prices for a brand like that in the market. So I think that the key takeaway for California in 2022 is it's going to be a continued year of price compression. I think you're absolutely correct. We will see some retail doors probably shut down or look to be sold. So you'll see some consolidation and you're going to see probably a calling of brands around a selection of brands that can either justify their premium pricing through great quality or are able to compete with margin at the lower price points to take the value shopper i think that's going to be the that's how we're looking at the story for california for this year and how we're positioning the business to compete i appreciate the colors thanks guys

Thank you, Scott. I would now like to hand back over to Charlie for closing remarks.

Yeah, I want to thank everybody for the time this morning. And again, very exciting deal, very exciting news. And we look forward to providing some more information on our next quarter's call. Have a great day, everybody.

Thank you very much for joining us today. You may now disconnect your lines. Have a good rest of your day. Thank you.