Cresco Labs Inc

Hello, everyone, and welcome to Cresco Labs' second quarter 2022 earnings conference call. My name is Charlie, and I'll be coordinating the call today. You will have the opportunity to ask a question at the end of the presentation. If you'd like to register a question, please press star followed by one on the telephone keypad. And I hand over to your host, Megan Kulik, Senior Vice President of Investor Relations, to begin. Megan, please go ahead.

Thank you. Good morning, and welcome to Cresco Labs' second quarter 2022 earnings conference call. On the call today, we have Chief Executive Officer and Co-Founder Charles Bechtel, Chief Financial Officer Dennis Oles, and Chief Commercial Officer Greg Butler, who will be available for the Q&A. Prior to this call, we issued our second quarter earnings press release, which has been filed on CDAR and is available on our investor relations website. These preliminary results for the second quarter of 2022 are provided prior to the completion of all internal and external reviews and therefore are subject to adjustments until the filing of the company's quarterly financial statements. We plan to file our corresponding financial statements in MD&A for the quarter ended June 30th, 2022 on CDAR and EDGAR later this week. Certain statements made on today's call may contain forward-looking information within the meaning of applicable Canadian securities legislation, as well as within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. These forward-looking 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 statements represent the company's beliefs regarding future-looking events, plans, or objectives which are inherently uncertain and are subject to a number of risks and uncertainties that may cause the company's actual results or performance to differ materially from such forward-looking statements, including economic conditions and changes to applicable regulations. Additional information regarding the materials, factors, and assumptions forming the basis of our forward-looking statements and risk factors can be found in our earnings press release and Cresco Labs filing on CDAR and with 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 all interim financial information is unaudited. In addition, during today's conference call, Cresco Labs will refer to certain non-GAAP financial measures such as adjusted EBITDA, adjusted gross profit, and adjusted gross margin, which do not have any standardized meaning prescribed by GAAP. Please refer to our earnings press release for the 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 as a substitute for or as an alternative to and should only be considered in conjunction with GAAP financial measures presented in our financial statements. With that, I'll turn it over to Charlie.

Good morning, everyone. Thank you for joining us on the call today. In Q1, we announced the acquisition of ColumbiaCare, putting us on a path to build what we believe will be the largest engine of value creation in the industry. We've always prioritized breadth and depth in the most strategic markets paired with best-in-class execution across all verticals of the value chain. We believe the ColumbiaCare acquisition aligns with these priorities and will solidify our leadership position at a key time for our industry. We're matching leadership positions in the states of today with exposure and infrastructure in the states with the catalyst of tomorrow. We're combining the branded product portfolio that U.S. consumers choose more than any other into an operational footprint capable of reaching over 70% of all eligible U.S. consumers. We're matching the most productive per store retail operating model with one of the largest combined retail store platforms in the industry. We're creating an unmatched diversification and balance of revenue by geography and by channel. And we're combining the most productive wholesale platform in cannabis with verticality. which best positions us to compete as state markets continue to mature and evolve. In short, we're creating a company built for leadership. We're making progress towards closing the acquisition, checking off milestone after milestone. HSR review, the Columbia Care shareholder vote, and the approval of the Supreme Court of British Columbia have all been completed. The great working relationships our companies have built with state regulators has facilitated progress towards individual state approvals, And our asset divestiture process is on track. We have multiple bidders for each asset. We've executed LOIs for each, and we're working through the diligence process and moving towards definitive agreements, giving us confidence in receiving north of $300 million in gross proceeds from the process and a closing date projected around E-Rent. Turning to the quarter, we're pleased to report solid results in the face of an unprecedented macro environment. We generated $218 million in revenue, representing a 4% year-over-year growth. We've gained or held branded market share in every state, with the exception of California, where we purposefully reduced exposure last year. For BDSA, we've maintained our industry position as the number one wholesaler of branded cannabis, the number one branded product portfolio chosen by consumers, and the number one most productive per-store national retailer. Our adjusted gross margin was 53%, a roughly 200 basis point improvement year over year in a market where prices fell between 10 to 30% depending on the state. And our adjusted EBITDA margin was 23% of 150 basis points year over year in the face of unprecedented inflation. We recognize the challenges currently facing the cannabis industry and the tough macro backdrop. In this environment, we're managing that today while remaining focused on the big picture and the long game. We're holding a growing market share, driving efficiencies across the company to maintain margins, and we're preparing for the integration of ColumbiaCare to generate substantial future growth. Now let's again review our proven playbook of the three specific ways Cresco Labs is delivering long-term growth and shareholder value. One, developing the most strategic geographic footprint. Two, being the leading branded cannabis portfolio. and three operating the most productive strategic retail network. So number one, we're developing the most strategic market footprint. We believe our longstanding strategy of being in the states that matter and obtaining meaningful and material market share therein is the recipe for long-term success in any CPG category. Our current 10 state footprint includes $7 billion plus markets, in which we have the leading branded share position in the three robust and competitive markets of Illinois, Pennsylvania, and Massachusetts. We're executing our playbook to expand our market share in other states with opportunities for gain like Florida, Ohio, and Michigan. While we won't have access to the most significant driver of industry top-line growth this year, the state of New Jersey, we do have exposure through ColumbiaCare. In the interim, we know that strengthened market share and continued share growth is the sign of a best-in-class operator, and we look forward to bringing Cresco to the Garden State in 2023. Over the next three years, there are an additional six large markets expected to switch to adult use, New York, Pennsylvania, Ohio, Virginia, Florida, and Maryland. Given our combined footprint with ColumbiaCare, we will have exposure to all of them, and we'll have leading share positions in several. This is arguably the highest value footprint in cannabis, 180 million Americans, all 10 of the 10 highest projected 2025 revenue states, and exposure to the largest growth drivers. The acquisition will more than double our retail footprint, give us number one branded or retail share position in five markets, and optimizes our operational footprint across markets. It is this level of strategic breadth with the depth that ensures growth, diversifies geographic and channel revenue, and creates an industry leader. Number two, we maintained our position as the number one branded product portfolio for BDSA. Again, in Q2, our net wholesale revenue was an industry-best $95 million. Also, again, Cresco Labs has the industry's number one portfolio of branded products chosen by U.S. cannabis consumers. number one portfolio of branded concentrates, number two portfolio of branded vapes, and a top five portfolio of branded edibles. We held a good share of branded products sequentially during the quarter in every market except California, where we saw a 20 basis point sequential decline. Over the last few quarters, wholesale has been a more challenging business with price compression impacting wholesale more than retail and vertically integrated operators giving preferential treatment to their own brand, even if they have lower velocity. Despite this, in both Illinois and Pennsylvania, customers once again spent more money on Cresco Labs' branded product than any other company as we maintained our number one position in both markets and held share. For the first time, we've also taken the number one branded share position in Massachusetts for BDSA, making this our third billion dollar plus market with the number one market share. Last quarter, we talked about some of the challenges we had to overcome in Massachusetts, and we're starting to see the hard work that we put in pay off. as we've improved cultivation yield, THC percentages, sales processes, and generally aligned our newly acquired assets with Presco Lab standard operating procedures to grind out market share in this very competitive environment. This type of performance gives us tremendous confidence as we approach the integration of ColumbiaCare. When we get asked again and again, do brands matter? I simply answer, absolutely. When given a choice, consumers are choosing our brands more than any other, even though, for the most part, we have less-owned shelves. Despite the current move to verticality, with regulatory caps in most markets, the opening of 185 more dispensaries in Illinois, and 150 independent dispensaries set to start the New York Adult Use Program, gives us a preview of how the future structure of this industry will likely look. It will validate our underlying thesis that cannabis is CPG, and will show the strength we're creating through our branded product sales and distribution capabilities. Number three, operating the most productive retail network in the most strategic markets. Q2 retail revenue was $123 million with same store sales growing 6% year over year and 3% sequentially. Sunnyside continues to rank number one among the scale national operators with an average quarterly revenue of $2.5 million per store across our 50 stores. Our team is doing an excellent job of maximizing the value of every trip in the face of a weakening consumer dynamic. Through our sophisticated e-com platform, basket-building promotions, and in-store cross-selling programs, we've been able to engage with our shoppers to maximize sales per visit. In Illinois, for example, our top quartile of Sunnyside.shop customers made 17% more trips than a year ago. With the launch of new engagement projects like loyalty, text offerings, and suggested selling, we'll continue to build sales from our large community of shoppers. While sales growth has been decelerating due to price declines, what's most important is that new shoppers are entering this category every day. For example, during Lollapalooza in Chicago, our River North City stores saw a record number of first-time shoppers, and overall units were up nearly 30% over last year's festival weekend. While pricing dynamics are muting this impact in the immediate term, this data point during the highest inflationary period in over 40 years is incredibly important for underwriting the durability of cannabis and the future potential of the overall thesis. Our retail sales growth hasn't reached its potential due to some delays in opening new retail stores in Florida and Pennsylvania. We've taken the steps to resolve these issues and replenish the growth pipeline. You'll see openings later this quarter. with more in Q4 and then Q1 of 2023. The ColumbiaCare acquisition will more than double our retail footprint, which paired with our industry best productivity and brand portfolio creates an ideal platform for growth. With the industry prioritizing vertical integration, we saw this trend coming and proactively secured a much wider retail footprint and balanced channel position to ensure that our incredibly popular products get the share of shelves they deserve. Before handing it over to Dennis, I want to thank the Cresco family for everything that they accomplished this quarter. They've done an incredible job of holding and gaining share in almost every market while managing through the macro headwinds, leading the industry's efforts for legislative progress at the federal level, and preparing the company to close and integrate one of the largest and most transformational M&A deals this industry has seen. In times like this, leaders lead, and I'm very fortunate to be a part of this team full of leaders. With that, I'll turn it over to Dennis to discuss Q2 results.

Thank you, Charlie, and good morning, everyone. I'll be reviewing the financial results from the quarter, then highlighting a few items from the balance sheet and discussing our capital position. As Charlie mentioned, we're happy to report that our team generated $218 million in revenue in Q2. This reflects sequential revenue growth of 2%, resulting from same-store growth of 3% and flat wholesale revenue in the face of industry-wide price pressure. Year-over-year revenue growth of 4% was muted by our decision to exit third-party distribution in California at the end of Q3 of 2021. Here again, we've demonstrated that we're not afraid to make the tough decisions to add shareholder value and position the company for long-term, sustainable, profitable growth. Our retail performance was particularly strong, growing 22% year-over-year driven by same-store sales growth of 6% and the addition of new stores in Florida and Pennsylvania. This shows the health and performance of our underlying base business, but also highlights the importance of the organic incremental assets we expect to see later in the year and into 23. The retail team continues to demonstrate the power of prioritizing the needs of the consumer and developing repeatable and scalable systems to best address them, and the results show. On the wholesale side, the strength of our branded product portfolio and gains in the market share allowed us to counter significant pricing pressures and produce a flat sequential wholesale performance. Net wholesale revenue fell 12% year over year, but when adjusted for the strategic shift in California distribution, wholesale revenue was flat compared to Q2 of 2021. Given this overall trend, we're proud of the team for maintaining the wholesale revenue in the quarter and actually taking share. While we expect to maintain branded share positions in our markets, further price depression, delays in new independent store openings, and MSOs shift towards more verticality will likely disproportionately impact wholesale revenue compared to total market sales and create softness to our overall top line in the back half of the year. But this is temporary. With several new store openings in Florida through Q4 and Q1, our incremental store openings in PA in Q1 of 23, and incremental independent retail doors opening in our home state of Illinois in 2023, we'll see organic growth return to the wholesale channel and top line growth overall. Adding the expected close of Columbia Care Deal around the end of the year, we're well positioned to have an incredible 2023 and beyond. Despite the significant price compression in the most recent quarters, our team was able to expand adjusted gross margins by 200 basis points year over year to 53%. We saw a deterioration in the competitive environment in California last year and took the difficult but necessary steps to scale down our distribution business there. That decision combined with improvements in yields, reaching scale in more markets, and our entrance into Florida contributed to our gross margin expansion. Our ability to recognize industry trends early and proactively respond to the changing market dynamics enabled us to maintain or grow margins in a difficult macro environment. Looking ahead, our goal is unchanged, to maintain gross margins above 50%. We expect to continue to offset price compression and maintain margins as we realize improvements from the investments we're making today in automation and processing and packaging, as well as increases in operational productivity driven by our incredible leadership team. Adjusted SC&A expense, which excludes share-based compensation and non-core items, saw a small increase of $1.3 million to $71 million, or 32% of revenue. The increase in SG&A was to staff the additional dispensaries opened in Q1 and marketing spend associated with 420. We expect SG&A to be flat to slightly down in the second half as we appropriately manage our expense plan to address the near-term macro environment while continuing to direct resources toward our long-term company priorities, including the integration of ColumbiaCare and expanding retail operations. We remain good stewards of expense management while maintaining our leadership position in social and regulatory reform in the cannabis space. This is what leading companies do. Adjusted EBITDA for the second quarter was $51 million, represent a margin of 23%, relatively flat compared to Q1. Our goal is to maintain adjusted EBITDA margins at the current level through cost controls and operational efficiencies in the face of market pressures over the next two quarters. Cash used in operations was $7 million. In the quarter, we made tax payments and distributions of $67 million relating to 2021 and Q1-22 extension payments. Of this amount, $43 million was tax payments to non-controlling redeemable unit holders and other members and flowed through cash flows from financing activities. In addition, Q2 included second quarter estimated tax payments of $6.3 million and tax distributions of $15 million. Overall, we paid $89 million in taxes during the quarter. It's going to be really good when 280E goes away. Second quarter gross CapEx was approximately $14 million. We expect our capital expenditures for the remainder of 2022 to be approximately $35 million as we continue to optimize and rationalize our national footprint. One of the many benefits from ColumbiaCare acquisition is the positive impact we expected to have on our need this year and in the future for CapEx to drive future growth. We are comfortable with our existing cash position, the strategic financing available to us, and the expectations for proceeds from the divested assets. In closing, there has never been a time in this industry when leadership, scale, and financial strength matter more. We are facing unprecedented headwinds from inflation, taxation, cost of capital, but also unprecedented opportunities for growth from regulatory changes on the horizon, strong consumer demand, untapped efficiency and production, and consolidation opportunities. We are in a strong position today, and that position will only strengthen once we complete the ColumbiaCare acquisition. And now I'll pass it back to Charlie for some closing comments. Thank you, Dennis.

I'm incredibly excited about what lies ahead for Cresco Labs and for this industry. While we all need to manage through the very unique macro pressures of today, it's important that we continue to look down the field. The outlook for U.S. cannabis is stronger than ever as cannabis remains the next major consumer products category in the United States. The industry is proving itself to be durable. While top-line market performance has decelerated in the face of the worst inflation in 40 years, The number of cannabis consumers and units sold is up. We continue to see progress at the state level as long-awaited regulatory catalysts in states like New Jersey and Illinois begin to unlock. The start of adult use in New York will happen in the coming quarters in Virginia in Q1 of 2024, and step function changes in a handful of other very large and influential states is expected in the next two years. Operators continue to prove themselves resilient. while we're subject to draconian tax provisions and can't access the traditional institutional capital pool that is truly sitting right on the sidelines and ready to jump in when they can. I'll reiterate what I mentioned in our Q1 call. We've never been closer to achieving federal reform on cannabis than we are right now today. Since our Q1 call, the Senate Majority Leader officially filed a cannabis specific bill and the Senate held its first committee hearing regarding cannabis legalization ever. Again, it reinforces now is the time to lean in. We are. We'll keep leading these efforts on behalf of the industry because we understand it's the ultimate unlock, and it takes leaders to drive this change. In closing, the macro and industry headwinds we're managing make us so proud of our Cresco team. With our operational and strategic initiatives underway, we'll continue to keep our heads down, execute on the business, put the pieces in place with long-term leadership, and achieve our vision of being the most important company in cannabis.

With that, I'll open the call for questions. Thank you.

If you'd like to ask a question, please press star followed by one on your telephone keypad. If you'd like to withdraw your question, please press star followed by two. When preparing to ask a question, please ensure you're unmuted locally. As a reminder, star followed by one on your telephone keypad. Our first question comes from Aaron Gray of Alliance Global Partners. Aaron, your line is now open. Please proceed.

Hi, good morning, and thank you for the questions and a nice quarter, especially, you know, given the relative macro backdrop. So, Charlie, I want to talk a little bit, you know, about the brands, you know, movements number one position in Massachusetts, you know, third there. You know, I want to talk about how you're seeing the relative pricing kind of overall for some of these markets where we're seeing pricing pressure, you know, how comfortable, guys are with your own portfolio and then secondly how you're liking the current mix between premium mainstream and value products because we've seen a number of your peers you know introduce some more value products announced in the recent months so how you're looking at relative pricing and the mix between you know the different pricing tiers um so you can continue your sex and your success in terms of the wholesale thank you yeah aaron thanks for thanks for the question um

You know, this goes back to something we've talked about all along, right, the importance of brand. And especially in a price-compressed environment where margin pressure exists, brand architecture is very important. Being able to meet the consumer where they want to be met so that good, better, best strategy. That's why we originally even developed the House of Brands approach that we developed from the very beginning. So, again, I feel like our portfolio is doing the work that it was built to do. And as long as we continue to offer the highest perceived value to the consumer at each of these category levels, we'll continue to be effective. As it relates to the specific markets, Greg, do you want to add some color?

Sure. I think your first question was on pricing. We do expect to see price compression continue into the back half of this year as supply in many of these markets like Pennsylvania, Illinois, and Massachusetts continues to come online and putting some price compression there. I think to Charlie's point, what we are encouraged by in our portfolio is we were one of the first to get out into the value segment, and we've been able to take material market share with high supply across our markets. We're pleased with that. But we were also able to bring FluorCal to market in Illinois at the premium price point. And its success in this market and ability to take share is another example of the right quality product still can command higher prices in the market. So our plans for Florical is to continue to expand that into different markets. So we are encouraged with the strength of our brands, the quality of our products, and our ability to fight price, either by offering higher quality products or finding ways to drive greater margin in our value brands.

Great. Thanks for that. Really appreciate that color. And then second question for me, just as we look at mature markets, so for California, you guys obviously exited some of the third-party distribution last year, but still have some exposure there. And then we'll be taking on exposure to Colorado with the pending ColumbiaCare acquisitions. So I want to get your take in terms of how you're looking at markets such as California and Colorado, where you are seeing pricing pressure there, obviously, at lower levels, so more difficult to be profitable. So And how do you view markets like that? You know, truly talk about kind of the long-term, you know, brand and importance of markets, you know, such as that, but in the near term, and obviously, you know, more difficult to generate properly there. So want to get your take on how you view on those today. Thank you.

Yeah, certainly. And, and you're right, you know, with the, with those markets sort of at the stage they're in and in their maturity, um, you know, it's important to, to be in those markets. Those markets are, you're talking about the largest and second largest cannabis markets in the world. But you want to be present, you want to be relevant, but you need to make sure that you're not exposed to allow those markets to negatively impact the rest of the body. And as it relates to our increased exposure in California through the Columbia Care Deal, it's really more of an optimized footprint. It allows us to have verticality there. And same in Colorado with the footprint that we'll be acquiring through ColumbiaCare. It has the largest retail footprint in the state. So really verticality is going to be important. It also helps with our ability to control our brand presence and positioning on shelves. So we'll manage through it, but both markets are important for the exposure to the consumer base and for brand equity that can be built.

All right, great. Thanks very much for the call, and I'll jump back into the queue. Thanks, Aaron.

Thank you. Our next question comes from Andrew Bond of Jefferies. Andrew, your line is now open.

Hi. Good morning, all. Andrew Bond on the line for Owen Bennett. Thank you for taking our questions. So just wanted to go over your retail strategy a bit. Retail sales growing nicely despite some of the pressures you mentioned and appreciate the metrics you gave around same-store sales. Just based on the relatively flat retail sales mix, Cresco's growth doesn't seem to be driven by kind of an increase in vertical shelf space, correct me if I'm wrong, like a lot of other competitors. So can you talk more specifically about that and what's working in your stores, maybe some of the retail tools or strategies that you're looking forward to implementing as you eventually integrate those ColumbiaCare stores post-acquisition? Thank you.

Sure. Thanks for the question. From a retail strategy standpoint, we continue to, again, try and address the needs of the consumer. Stakeholder-focused organization, we do this across our entire platform. So understanding what the consumer that's coming into the store wants, whether that's an expedited experience with an online ordering system or that in-store personal touch that helps shepherd them through the decision-making process. So strategically, we want to operate high-volume products Retail with great locations. It's something that, as we've talked about in prior calls, it's a muscle that we've built over the years. We have become a fairly effective retailer, as noted from our revenue per store metrics. And it's something that will continue to drive, especially as the industry goes through these periods of time where verticality becomes more important and owning your shelves becomes more important. We're excited to incorporate the assets that come with ColumbiaCare and get that more balanced channel position to allow us to compete the best that we can compete in a market-by-market approach. And Greg, as far as the tools, do you want to comment on tools?

I think the big things you'll see from us is we believe that our traffic will be driven by the best assortment possible. And so I think one of the questions you asked is our use of verticality in our own stores. Historically, we've always tried to maximize the assortment of our brands and partner brands. And then we'll continue to do that to what makes sense to help drive foot traffic and delight our shoppers. From a tool perspective, what we've really built in Sunnyside that's helping us drive not only our retail business but our wholesale business, is insights in the shopper behavior and understanding what they're looking for, at what price points, in what forms, and a lot of those insights are being used to fuel how we think about innovation and capabilities across our platform. And we've seen successes as these launch brands have nailed it to capture some pretty good market share. From our capabilities and funding side, our folks in the black half this year and what you're going to see from us is programs like loyalty, where we're going to help not only collect information about how our shoppers shop, but also drive loyalty to our stores, but also other ways to grow our baskets through technologies like suggestive selling, add-ons. And so our focus really is how do we get the most value out of every shopper coming through our doors in the back half while collecting data that enables us to really start to customize not only messaging, pricing offers, but innovation to those shoppers.

Great. Very helpful detail. Thanks, guys. And for my second question, maybe just following up on your comments on Florical and expansion to new states. Obviously, it's been a highly successful brand for you in California and now just recently rolling out into Illinois in 2Q. Can you remind us which states have already launched Florical? Is it just Illinois so far? And then what's performance been there relative to your expectations? And what additional states are you planning to launch the brand in the balance of the year? Thank you.

Why don't I take that? You know, as you said, we've been very pleased with not only the progress of Florical in California, in a very tough market dynamic we've launched in Illinois so far. It hit our expectations, in fact, over-delivered our expectations on not only how the product was going to be received by customers, but its ability to command a premium price during this current macroeconomic conditions and pricing conditions. So it shows that quality products can get a premium price from shoppers. Next up for us as we think about Floritel's opportunity, we're looking at markets like Pennsylvania, Michigan, and Massachusetts. All would be kind of next in our line as we continue to roll that success across our footprint.

Great. Very helpful. Thank you. I'll jump back in the queue. Thank you.

Thank you, Andrew. Our next question comes from Pablo Zuanich of Cantor Fitzgerald. Pablo, your line is now open. Please go ahead.

Thank you. Good morning. Charlie, two questions related to capacity. So maybe remind us where you are in New York in terms of current capacity and expansion plans. I mean, as those new 150 licenses open their stores, will you be ready to supply them? And then the second question related to the same topic, you know, just a reminder, over the next 12 months, Where can we see new capacity in driving in your wholesale business or we don't really have any new capacity in a major way coming in over the next 12 months? Thank you.

Thanks, Pablo. So where we stand in New York is moving forward with, again, both us and ColumbiaCare having assets in the state. We're moving forward with construction and CapEx plans as it relates to our property. but with an eye towards what the combined footprint of assets will look like and how best to optimize it. You know, depending on when that market starts, ColumbiaCare currently has fairly large-scale production in the space in the state already. And depending on when adult use kicks off there from the downstream production manufacturing capabilities, will have, again, it will be varying degrees depending on when adult use really launches in that state. But by mid-year next year, we will have full production capabilities on the processing side too. As it relates to capacity in other markets, additional capacity, we're, again, prioritizing the ColumbiaCare acquisition, so additional capacity will come online in various states based on combined footprint as opposed to ongoing CapEx projects under CRESCO.

Okay, thank you. And one last one, a not-to-need pick. I think in the past, when you talked about gross proceeds from the divestitures, you had talked about $300 million to $400 million. Today, you said $300 million. I think that's understandable in the current context, but can you clarify there, or am I misreading the comments? Thanks.

No, I think we were just confirming that it would be north of $300 million. It'll be somewhere in that range, the original range of three to four.

Okay, thank you. Thank you. Our next question comes from Derek Delay of Canaccord Genuinity. Derek, your line is open. Please go ahead.

Yeah, thanks, and good morning, everybody. Just on the ColumbiaCare transaction, obviously you've made a lot of headway in terms of securing approval. Can you just talk about what's left? Do you need state-by-state approval? Do you need municipality approval in some cases in some states? What's left there?

Thanks, Derek. I would say just overall, again, reiterating the regulatory approval process is going well. Really proud of the team because it's a lot of work. You're talking about all 17 states that have some sort of approval or ownership transfer process that we have to manage. So it definitely is a big project, and the teams, the combined teams on the Columbia Care and the Cresco side are doing an incredible job of managing it. But you're right, depending on the state, they vary in degrees of difficulty and sophistication in what the process is. We've made great progress. I think, as we mentioned, or I think Nick mentioned on his call, about half the states are almost to completion point. And the other states, the divestiture-related states, are, of course, going to be sort of the ones that we'll continue to work on through the divestiture transactions and whether it's state level or municipal level it does depend on the state but progress is is far along and under any of the circumstances in an area that we're confident in in being able to manage thoroughly so feeling good about it okay good and then just switching gears a little bit just to the to your dispensary side

In terms of your new store openings or even, you know, what you've seen in the past, you know, you mentioned your Sunnyside stores and had into a half million in revenue per store. Can you comment on what the returns on that looks like? Like, for example, what are the typical payback periods you're seeing or maybe compare the paybacks periods you're seeing now versus what you saw, you know, two years ago when you were opening stores?

Sure, Greg, take this one.

Yeah, good morning, Derek. I think from a general perspective, what we've talked about in the past is, and this is pretty consistent, I think, of what our peers look for as well. We have an internal rate of return that we look at that's somewhere in the three-year range, two to three years. We don't overly share that, but I would say from where these assets in cannabis continue to perform, we're not seeing any sort of change in that payback period. We're able to generate revenue and profit out of those stores that are holding those standards. Okay, great. Thank you very much.

Thanks, Derek. Our next question comes from Vivian Azar of Cohen. Vivian, your line is now open. Please go ahead.

Hi, thanks. Good morning. Charlie, I recognize it's an incredibly dynamic backdrop and your crystal ball is probably not perfectly clear, but as you observe the current market dynamics, how has your thinking around the hierarchy changed of priority states on a pro forma basis changed, if at all, for 2023? Thanks.

Thanks, Vivian. So as far as the prioritization for states in 2023 has changed, I think, you know, again, if I went back in time, regulatory approvals or sort of the unlocks from a regulatory approval standpoint have probably the largest impact. on how the positioning evolves over time. Again, I think if I went back a year and a half ago, I would have expected some of the 185 stores to be open in Illinois. I think originally we were anticipating New York starting in end of Q3, beginning of Q4 and 22 maybe. Jan 1. I don't know if that's the beginning of 2023 is still realistic. We'll see. We're looking for some good updates from New York here in the near future. But that's sort of how we've, you know, I would say regulatory change has probably the largest impact on the way that we think about states. And then the ability for sort of the verticality play right now and through the rest of this year is definitely something that is taken into consideration as we're looking at sort of how to approach states. So again, feeling really good about the ColumbiaCare transaction and the benefit that that gives us from a balanced approach, both from a geographic diversity standpoint and from a channel diversity standpoint. I think balance at this stage of the industry is very important.

Yeah, absolutely. Certainly, I can appreciate that. the frustration around New York, maybe first half of 23. But just a double click on your comment on Illinois is my follow-up question. I know it's very early days, but certainly you guys were, you know, involved in, you know, involved with the social equity participants and licensed winners. So how are you thinking about them as potential customers? And are those conversations starting, albeit very early days?

No, certainly those conversations, again, have been ongoing. We've been a partner to the initiative from the very beginning with the passing of the legislation and, of course, when the original announcement of recipients was made. So it's been tough to have our partners be put in a position that they've been put in over the past couple years with the delays. But we think that there's a tremendous opportunity for them to be good partners of ours in the coming years and for us to them. Now, I don't know if all 185 are going to stay where they're at. I think you're going to see some additional entities make some acquisitions of some of those licenses. And again, there's puts and takes and pros and cons to that, but I think The interest in the Illinois market is there. The opportunity in the Illinois market is there. And so we're really excited to see that unfold and, again, be a good partner to those groups coming into the state.

Understood. Thank you.

Thanks, Vivian. Our next question comes from Andrew Parthenio of Stifel. Andrew, your line is open. Please go ahead.

Hi, good morning. Thanks for taking my questions and congrats on the good quarter here. You mentioned receiving over $300 million for the divested assets, which I think was previously discussed to fund CapEx and pay down debt. Understanding that you may not be comfortable putting a CapEx number out there for after 2022, but maybe you could talk about leverage and how you see your balance sheet What does an ideal leverage ratio or look like and how should we think about raising capital when cost of equity is high and cost of debt is rising in this inflationary environment?

Thanks, Andrew. We're going to have Dennis take that.

Thanks, Andrew. You know, as we've talked about on previous calls, the amount of CapEx that we'll need to spend for the balance of this year will come down considerably. As we look at the benefits of the ColumbiaCare acquisition and look at our combined footprint, we had previously talked about a number of about $100 million. That number will drop to about $60 to $65 million for the full year for Cresco Labs. As it relates to proceeds from the divestitures, we will continue to, the plan is to pay down some of the existing debt and have a leverage ratio in the one and a half range as we exit 2023. That'll be a combined reduction in the overall debt balance that we have as a company. And with the proceeds, again, we'll be able to have some money in our pocket so that we don't anticipate having to do any type of raise. There won't be any type of equity raise in the foreseeable future. So we feel that we'll be in a really good, strong cash position to pay down our debt, increase our balance sheet, and improve our leverage overall.

Thanks for that, Keller.

And thinking about this quarter and near term here, could you talk a little bit about what the promotional trend was, quarter to quarter? It's impressive that you increased your gross margin in a seasonally higher promotional period. Q3, arguably, if you think about seasonality, could be a little bit less promotional. So could we see further improvement here? Or is the trend of price compression kind of negate any kind of seasonality factors? And if price compression does negate, where are you seeing the most impact in your portfolio?

So why don't I take this?

I think as we mentioned earlier in the call, we are planning and expecting to see price compression continue across many of our markets. That's been the case for the first half of this year, and there's nothing to suggest as we get into Q3 that's going to slow down. And so we've planned for that. We think that's going to probably see itself intensify the most in markets like Pennsylvania. We will continue to see supply come online, putting pricing pressure in that market. We don't expect Massachusetts to give up on price promotions. And so we're planning for that, and we'll see as Florida. Florida was a pretty aggressive price promotion coming into the year, slowed a little bit in the market, but that could continue as we get into the back half of the year. So those are the markets we see intensification. For us, because we're planning for that, it's about how are we managing costs in those markets to make sure that we can respond with price if we have to and ensure we're holding margin. And so proactively planning for how prices might come down, which we've been doing, and then starting to manage our cost base to support margin growth, even if that happens, is where we're focused. And hopefully we will be surprised here that pricing doesn't hit as hard in the back half of the year, but we are taking all the actions now to make sure, if it does, that our margins stay strong.

Thanks for that. I'll get back in the queue. Thanks, Andrew.

Thank you.

Our next question comes from Kenric Tai of ATB Capital Markets. Kenric, your line is now open.

Thank you. Good morning and congrats on the quarter. Charlie, in Illinois, can we speak to, we've seen each of the last number of months, sequential declines in the average basket in Illinois. Can you speak to even directionally, not just how your average basket is trended in the state, but also perhaps just the gap relative to the average basket and how you would see that evolving in the back half of the year? Apologies.

Thanks, Henry. I'll start and then Greg will add some more color to it, too. But, you know, I think what we're seeing in Illinois from sort of the gradual slide here in basket size is not unique to Illinois. I think this is a dynamic that exists when you have the macro headwinds and the macro pressures that we're seeing. When you have gas costs, what gas costs, you're going to see different behaviors in consumers, whether that's less frequency in shopping or whether that's trading down. in categories. So again, it's one of the things that a comprehensive portfolio strategy and then in-store sort of activities and basket building tools we're using to try and counter. But I don't know that I would limit it to Illinois. And Greg, any additional color?

I think specifically kind of right here on Illinois, what we've seen, and this is why we've highlighted the fact that the year could look tough from a growth perspective in some of these markets, is each of these seasonal lifts that we expect to see in a quarter for the first half of the year have not been hitting as high as expected. And so that is showing you that it is, there's price compression for sure happening, which is impacting baskets, but there's also slowdown in foot traffic. And I think if you look at it from a retail perspective, whether it's our retails or others, Most many of us expect to see seasonal lifts of foot traffic as we got in the summer months. We're seeing a little bit of that, but nowhere near what we've expected to see. And so that reduction in traffic with a bit of price compression is definitely putting some pressure on top line revenue. And to Charlie's point, that is not an Illinois specific. That's across markets. You're starting to see that growth or that compression on growth. Car focus. has always been delighting our shoppers. And so as we get into the second half of the year, we're planning for a potential scenario where foot traffic continues to be pressured. And so finding ways to increase the value of every shopper transaction, whether that's getting to add an extra item to the basket, whether that's more selective on how we're thinking about price promos, is how we're going to manage through it and how we think we're going to continue to hold our above fair share in many of our markets as we get into the second half of the year.

Really insightful, thank you. And just switching quickly to Massachusetts, obviously nice to see the move there and your sort of taking of a number one position in the state. Can you just speak to what were the key fixes that you needed to make to the Massachusetts business and how sticky do you think those will prove and how sticky by definition do you think your position will be in the market again as we look through the back end of this year into next? Are the Massachusetts fixes sticky, or is there some noise in that movement in quarter?

I think, again, just taking a realistic look at Massachusetts, we integrated a fairly large acquisition there at the very beginning of the year. It's one thing to close a transaction, and it's another to fully integrate. I think what you're seeing from us is the benefits of the work and the discipline and the integration process bearing fruit. And improvements, as we mentioned on the call, from a yield perspective, from a quality perspective of product coming out, it really goes back to the fundamentals of offering the highest perceived value to the consumer. It's always a good strategy, right? So I think that's the execution of the traditional playbook bearing fruit, and very happy to see it. Greg, anything you want to add?

I think the big things I'd add for that is as we've looked at our share and your questions on stickiness, absolutely. We believe it's sticky. We gave up some share in Q1 to Q2 because we were moving through some inventory that we had to with the integration, which we were selling heavy as Q4, Q1, we did not have in Q2. So the growth you're seeing in Q2 to become the number one is our go forward portfolio coming into the market. And so on the vape side, We've seen some nice growth. The team has done a tremendous job of getting out there and explaining what makes our product superior with liquid live resin and taking some share. And then as we get into the back half of the year, as we've mentioned on previous calls, we expect to see improvements in our flour quality, higher potency, more strain diversity, which is going to give us an opportunity to go take some share on flour as well, even amongst the continued price compression exists in flour in the market. What you're seeing in Q2 is the beginning of getting the right house of brands into the market, and our view on that is we're going to continue to grow from there.

Thanks so much.

I'll be back in Q. Our next question comes from Matt McGinley of Needham & Co.

Matt, your line is now open. Please go ahead. Great.

Thanks for the detail on the back half outlook and your prepared remarks. I just want to make sure I have the moving pieces right. It sounded like you thought you would have some retail dollar growth from unit addition, but you might see some decline in wholesale given price compression. And then Dennis said that the G&A dollars would go down a little bit, but you were targeting EBITDA rate to be flat at around 23%. So I think that implies your gross margin will probably be flat or down a little. Is that about the right shape of what you're expecting into the back half?

For the question, Matt. So yeah, you're spot on. So we do, we will continue to manage our SG&A costs as we have for the last several quarters. It's been relatively flat. We will continue to manage that. We do expect to see a slight decline in the second half from our current levels on the SG&A front. We are, as we've talked about several times now on this call, there has been the price compression will put some pressure on our gross margins. We're looking to offset that through automation and improved yields and productivity at those sites. But we do expect there to perhaps be some pressure on gross margins, which will allow us to keep our adjusted EBITDA margins relatively flat sequentially.

Great. And on the question of cash flow in the earnouts, you had that $69 million in cash outflow. I think that was related to cultivate earnouts this quarter. And I think, Dennis, you had some of that with tax-related. I'm not sure if I mixed some of those together, but I know you had some other earn-outs with World of Harvest-related dispensary opening. So overall, what do you expect the cash payments will be through year-end, and how should we think about the timing of those payments, given I think some of those were tied to specific deliverables around the store openings that you probably have good visibility into?

Yeah, so from a cash flow perspective, as we talked about, there was $89 million of taxes that were paid out in the quarter. Now, due to the structure of the company, that does show up on two separate lines, but there was a huge tax payout as it relates to this quarter. And again, we have 280E to thank for a big portion of that. If we look at some of the earnouts that you talked about, those were... There was some cash component to that, but there was a larger component to that that was related to equity that had been provided as part of those transactions. So the cash disbursements was fairly low as it relates to the earnouts in the quarter. If we look at our cash position going forward, we feel really good about where we're at from a cash perspective, our ability to generate cash from our existing business. The large tax payment is primarily behind us, and I feel pretty good about our position going forward.

Thank you. Thank you, Matt.

Our next question comes from Scott Fortune of Roth Capital Partners. Scott, your line is open. Please proceed.

Good morning, and thanks for the questions here. You mentioned a little bit on the operation improvements, improving yield production from outside. You did a good job at integrating in Massachusetts. But I just want to continue, kind of, if you call out further opportunities for production efficiencies as you look at your footprint, kind of, in the different states, and then how You look at that opportunity as you bring on the ColumbiaCare assets and production and operation efficiencies for those assets coming forward. Just a little further on continuing efficiencies to offset the pricing pressure that you're seeing.

Yeah, thanks, Scott. You know, the opportunities for further efficiency I think are great across the sector. Historically, the ability to benefit and create the scale and efficiencies from automation is limited in this space. That's starting to lessen, I think, from the barriers or the inability to create that efficiency is starting to lessen. We are developing the scale in our markets, in our underlying markets, that can afford us the ability to utilize automation to create greater efficiencies and the benefits that flow from them. And I think just as we continue to focus on continuous improvements from an operational perspective with our center of excellence, these are the types of things, again, the playbook in cannabis for each operator needs to continually evolve and get better. At least that's what we prioritize throughout the organization is this idea of continuous improvement. So it's something that you'll You'll see from us as we go forward. It's absolutely one of the benefits of the ColumbiaCare deal and why we're so excited about it is the opportunity to rationalize the dual sets of assets that we have in these various states. We can really create optimization in 2023 and on that neither one of our companies could do on our own. Now, that's not only from an operational perspective, but that's even from a back-of-the-house and SG&A perspective, too. So the synergies and the optimization that are going to flow from the ColumbiaCare deal are pretty profound. Very excited about it.

I appreciate the color. And then real quick, last question for me is just providing a little color on expectations of the Illinois program. retail store rollout and timing, obviously, you know, expect them all to come on board. How should we look at that cadence as you see these retail stores kind of getting licenses and coming on board and looking at second half and more primarily into 2023? Sure.

You know, as it relates to the stores opening in Illinois, Yeah, I think it's going to be a gradual turn on when it comes to the 185 license opportunities. There's certain certain groups, of course, are going to be better prepared to move forward than others. And so that's why we think we'll see some before the end of the year here, a nominal amount. But I think you'll see some get open before the end of the year. I think you'll see a gradual build throughout 2023 into the back half of 2023 and then some into 2024. You know, I think just being realistic about the preparedness and the capabilities of the large pool of recipients, it varies. It's one of the things that, again, makes us excited about New York. I mean, New York as a state is underwriting and investing in that program at a level that no state has ever done before. So when you can compare those two scenarios, you know, the 150 stores that are going to open in New York, very high level of confidence that those are going to get their doors open, that there's going to be shelves that need product on them. So excited for both states. But, you know, we're going to make sure that we do what we can to assist and get doors open in both.

Thanks, Charlie. Appreciate the color. I'll jump back in the queue.

Thanks, Scott.

Thank you. And our final question of today comes from Michael Lavery of Piper Sandler. Michael, your line is open. Please go ahead.

Thank you. Good morning. I just wanted to come back to the margins, and you called out a few of the drivers of, you know, puts and takes, but the discontinuation of the California third-party distribution sounds like it was a pretty big offset to a lot of the headwinds. Can you quantify how significant that was?

Yeah, we haven't provided any specifics on our margins in California. We made the decision, which was a tough decision to make, but to exit the third-party distribution business in California because it was a challenging business to be in, and it was diluted to our overall margins. The impact of that, certainly in the California market, helped improve the margins in California pretty dramatically. But when you look at the overall impact across the company, it did have a smaller effect, still a positive effect, That, in part, is what has allowed us to show some margin improvement sequentially. But again, we understand that there are pretty significant price compression factors that are offsetting some of the gains we're making in other areas. And all the things combined are what gives us confidence that we can maintain gross margins over 50% in the foreseeable future.

When you called out the yields and better scale and entering Florida as other positives, would, on the total company basis, the margin mix benefit from the discontinuation in California have been a bigger driver, or are they all about comparable? I guess just trying to understand where it ranks kind of in the hierarchy of things.

Yeah, somewhat comparable today, but as we continue to scale up in Florida, again, the vertical market there enables you to have much larger margins on our overall profile. So, we expect to see that opportunity in Florida will have a bigger impact on us going forward. But again, there's other headwinds that we're facing that will put pressure on margins.

Okay, that's helpful. And then just on the ColumbiaCare deal, you've just touched on some of the efficiencies and cost synergies. From the revenue side, are you underrepresented in those stores? Or, you know, is there sort of ways we should expect revenue synergies to give a lift as well? You know, once, you know, if you're underrepresented now, you could sort of, you know, improve, just get a distribution boost after it closes. Is there any, how much of that should we be expecting?

Yeah, this does. So there will be an uplift in that, certainly as we look to markets like California, where we don't have stores and we don't have that distribution ability to have the stores to put our product into. So there will be some improvements in terms of their overall position on our shelves, our product on their shelves and their stores. That is certainly an opportunity that will give us some uplift once that deal closes. Greg? Okay, thanks so much.

Thank you, Michael. At this time, we currently have no further questions, and therefore this concludes today's call. Thank you all for joining. You may now disconnect your lines.