4Front Ventures Corp

Greetings and welcome to Forefront Ventures' first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Andrew Toot. Thank you. You may begin.

Thank you, Operator, and welcome everyone to Forefront Ventures' earnings call for the first quarter of 2021. I'm joined today on the call by the entire Forefront management team. We have Leo Guntmaker, our CEO, President Carl Toscano, Jake Wooten, our EVP of Finance, Joe Felpham, COO, and our interim CFO, Pete Renner. Before I begin, I'm obligated to remind everyone that during the course of this conference call, management may be making some forward-looking statements that are based on current expectations and are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These results are outlined in the risk factors section of our filings and our disclosure materials. Any forward-looking statements should be considered in light of these factors. Please also note, at Safe Harbor, any outlook we present is as of today, and management does not undertake any obligation to revise any forward-looking statements in the future. So with that out of the way, let me give you a very quick overview of the call today. We have a lot to get through, and we're pretty excited to share some recent developments as our company enters a significant growth phase. As always, I'm going to start with reiterating our thesis and strategy. Then I'm going to provide some color on our first quarter results. and an update on the significant progress we've made in the business. I'll then hand the call over to Leo, who will go into a more detailed review of our operational trends, along with highlighting some milestones we achieved in the quarter as we continue to build momentum across our business. We'll conclude with Q&A session, where the entire management team will be available for any follow-up. So, with that out of the way, let me begin. I know we We have many new investors on the call that are newer to the forefront story. So I'll start again by outlining the forefront thesis and what we as investors are playing for. I firmly believe that we are entering a golden age for the cannabis industry as the pace of state legalization accelerates and reform on the federal level increasingly appears to be inevitable. From a pure investment standpoint, anticipated reforms in the banking laws should be a game changer, leading the way to cost of capital coming down for with financing from money center banks and eventual access to U.S. exchanges and broad-based institutional ownership in the industry. The business fundamentals of U.S. cannabis continue to be robust and appear to be strengthened. What we're witnessing here is the emergence of a massive secular growth industry that's still very much in its nascent stages. At forefront, we believe the sweet spot in the value chain in this industry is a low-cost production and distribution of cannabis consumer packaged goods. For the past six years, Forefront facilities have established a dominant market position in Washington state with a full line of products which are distributed to over 260 retail locations in that state. Our facilities are the number one edibles manufacturer and the number two flower producer with overall number two market share in Washington, outperforming over 600 license holders in one of the most competitive cannabis markets in the world. We did this while maintaining very attractive margins and profitability. So our thesis, as I always say, is really simple. We're replicating these tried-and-true production capabilities in large and nascent recreational markets of Illinois, Massachusetts, Michigan, and California. And all in, we currently serve an addressable market of over 76 million people. We're pleased to share today important developments as we execute on this thesis. So one, we continue to see our maniacal focus on execution taking hold in our business. Not only do we have a very strong top line momentum in Q1 that is carried into Q2, we have successfully set the table for the second half and beyond. Our operations and construction team have done an incredible job of controlling everything they can control. And as a result, two more critical projects, our Commerce California Production Center and Brookline Massachusetts Retail location are set to open imminently, under budget and largely on time. In almost every facet of our business, we are smarter and stronger than ever before. And consequently, it performed better in our core business than we projected. Secondly, our Q1 2021 system-wide pro forma sales were $31.4 million, an increase of 26% sequentially over the fourth quarter of 2020. All retail locations across the portfolio performed above our expectations expectations, a trend that has continued into Q2. Recreational sales in Massachusetts continued to build, and we showed 30% sequential growth in this estate. In Illinois, we showed over 100% sequential growth, as our second location in Calumet City came out of the gates strong in December and has never looked back. Q1 marked our third consecutive positive adjusted EBITDA quarter, posting $5.9 million in adjusted EBITDA or 19% adjusted margins. While above our internal budget, EBITDA margin in the quarter was negatively impacted by the ramp of our expanded growth facility in Illinois. The tripling of the Illinois cultivation facility's flowering canopy was completed on time and under budget in Q4, but the first harvest from the expanded facility was not complete until April, leading to a one-time higher than expected average cost per gram in the quarter. In addition, the harvest Harvest delay resulted in a disproportionate amount of lower margin third-party wholesale sales in the quarter at our Illinois dispensary. We believe this is one time in nature, and subsequent to the quarter, we have already more than tripled our Q1 Illinois harvest output through the first month of Q2. And we expect a meaningful rebound in margins in Q2 as we implement more of our Washington practices in our growing footprint. For our balance sheet, leading Q1 was in solid shape as of March 31, we had approximately 18 million of cash and 46 million of related party long-term debt, which doesn't come due until May 2024. We are feeling terrific about our current liquidity position and access to reasonably priced project capital. We anticipate the cost of capital in the industry to continue to come down with looming banking reform and increased investor interest in the cannabis industry. Point number five, circling back on my earlier comment, Our operations and construction team have been phenomenal. We are effectively on time and under budget with all our expansion projects, which is critical if these projects set the stage for future growth. Leo will speak specifically to our imminent and exciting interest into the California market, along with the anticipated opening of our third Massachusetts retail location in June. We also announced our plans in the quarter to exponentially expand our cultivation and manufacturing presence in Illinois. We are bringing our scale cultivation and production capabilities to our one of 20 cultivation licenses in the state that allows for 210,000 square feet of flowering canopy. We plan to begin construction on this project in Q3 21 and are incredibly excited for the phase one to come online late next year with roughly 65,000 square feet of flowering canopy and 70,000 square feet of production. So our thesis is proving out. We are successfully introducing the brands and products from Washington into new markets. The feedback we've gotten from our customers in Mass and Illinois have been fantastic. And now we embark on our much anticipated entrance into California, the largest cannabis market in the world. We're incredibly pleased with how our business is performing, setting us up for step function operating leverage as we continue through 2021 and beyond. So having set that stage, I'll now turn the call over to Leo Gontmaker, our CEO, who will delve a bit deeper into our assets by stage. state and provide some additional color on our near-term and medium-term plans. Leo?

Thanks, Andrew. Andrew did a terrific job of updating you on the strength we see in the industry and our business. 2020 was a transformational year for our company, which was achieved through focus, dedication, and the hard work of all our employees. We carried that momentum into the first quarter of this year, and it's continued into Q2. It's been a little over a year since our board appointed me CEO because of my deep understanding of cannabis business operations, as well as my business building capabilities, along with their desire for this to be an operator-led company. I've now brought that role in a culture that, as we say internally, is maniacally focused on execution, doing what we say we're going to do. Since March of last year, we've made tremendous progress as a company, right-sizing the cost structure, streamlining our business, and pushing deeper into our core states by leveraging the structural cost advantage our facilities developed in Washington into the rest of our license portfolio. Recall our investment thesis. We believe the sweet spot for outsized value creation in this industry is really around low-cost production and distribution of cannabis consumer packaged goods. Our facilities in Washington State are the number one edible manufacturer and number two producer of flour, with an overall number two share in the state. We outperform over 600 licensed competitors in possibly the most competitive cannabis market in the world. We've achieved this while maintaining very attractive margins and profitability. We're replicating these tried and true production capabilities in the large and nascent recreational markets of Illinois, Massachusetts, Michigan, and soon to be California. So the question is, how is the thesis playing out for us so far? Due to low-cost cultivation and manufacturing methodologies, And again, our maniacal focus on execution, we have successfully and profitably scaled products and brands from Washington into Massachusetts and Illinois. Let's start with Massachusetts. It's been 18 months since the opening of our cultivation facility in Worcester, which at conception, we were able to institute growing methodologies and SOPs developed over the years in Washington. Since our first crop in Q3 2019, we've experienced no failed harvests and demonstrated annual yields of well over 400 grams per square foot. In our acquired Georgetown facility, we continue to make improvements to the growing environment, including upgrades to the lighting, which have driven yields in excess of what we're accustomed to seeing in Washington. We've introduced all of our Washington brands into the Massachusetts market as well, without exception. The reception for our products has been fantastic, and we expect to continue to build momentum as word of mouth spreads. We've seen the brands we've brought to market pretty quickly take market share from the previous in-house brands that were being sold out of Georgetown, which is a great sign, and we continue to see the sales climb. We've implemented our extraction methodology, which enables consistent, repeatable feedstock for all our products, and introduced our production and packaging methodologies, which greatly enhance throughput and reduce labor. As we move forward, we look to continuing momentum in Massachusetts as both our WSDA and Georgetown facilities continue to ramp up. Our third Massachusetts retail location in Brookline is still expected to open for recreational sales in Q2. We've had to contend with some minor permitting delays, but our team has done a fantastic job of pushing the project and controlling everything we can control. Again, points to our maniacal focus on execution. and we currently expect to be making our first sales in Q2 pending final CCC approvals. Our upgraded cultivation in Massachusetts ensures that we'll have plenty of inventory to hit the ground in Brookline running hard. We're extremely excited about this store. Washington continues to stay steady with improved top line growth as wholesale prices have rebounded from their lows in 2018. Our facilities had a record quarter in the summer showing a big uptick in general in Washington across the board on flour and derivatives. Pricing is holding steady, and as volume has climbed, we have not had to drop pricing across the board on any of our products. This is an extremely encouraging and great sign because usually coming into Q4 and outdoor harvest and leaking into Q1, you start seeing a bit of a drop in flour pricing and a little bit of slowdown in sales. We're extremely excited about this trend, and everything points to it staying that way for now. In Michigan, we're pleased with how our team navigated a very choppy supply chain and increased competition. Downtown Ann Arbor was not the same in 2020 as years past due to closures downtown because of COVID and no University of Michigan students for most of the year. Even though we don't have the same purchasing power as some of the other retailers in the state, the relationships the team has made over the past eight years in business were able to carry us last year and beyond. So despite seeing competition double since 2019 and having less product available to us, we were still able to almost triple sales during our first full year of adult use. In Illinois, our South Shore Mission Retail reopened last July. We're back to revenue numbers we were seeing before the break in last May and seeing solid growth month over month. Further, our current Elk Grove Village facility continues to see progress. Our Washington facilities team took over leadership for this facility in Elk Grove in January 2020. And since that time, we've seen our yields climb from 290 grams per square foot to right around 375 grams per square foot pre-expansion. Our flower strains and brands have been very well received in the market, along with our recently introduced flagship flower brands, Funky Monkey and Legends. Expansion in Elk Grove was substantially complete on time and under budget. But as Andrew mentioned, our harvest in the expanded facility came on in April, which caused some one-time disruption to our margins in the quarter. With the expanded capacity online, we not only expect a rebound in company-wide margins, but increased wholesale revenue in Illinois as we move through the second half of the year. Also, and more exciting, as Andrew mentioned, we're preparing to commence construction of phase one of our build-out of project Big Daddy later this year in Q3. After replicating our facility's best practices from Washington into both Massachusetts and our existing Illinois grow, we have a tremendous amount of confidence that our scaled production techniques travel well, and Big Daddy will be yet another significant and continued validation of our thesis. This facility will initially be comparable in size to our Washington facilities, where our production numbers have consistently exceeded 350 grams per square foot. We expect yields at a big daddy to be in line with our more recent version of cultivation efficiencies we've been seeing in Massachusetts, namely over 400 grams per square foot. My team and I couldn't be more excited to bring our scaled, low-cost cultivation and manufacturing into the state and get the opportunity to compete head-to-head with some of the bigger MXOs with our experience playing in competitive markets. Last, in December 2020, our second Illinois location opened for retail in Calumet City. which is approximately one mile from the Indiana border. The grand opening occurred on December 15th, 2020, and the results have been absolutely fantastic. Calumet has quickly become our second biggest revenue dispensary behind Georgetown, and the momentum in Q2 has been amazing. In California, it's coming up on Showtime. The company's fully funded, state-of-the-art 170,000 square foot manufacturing-only facility in Commerce will be operational in Q2 of this year. We believe this is the largest cannabis processing facility in the world, which we know will become more efficient by a factor of 10 than our Washington processing facility. We're incredibly confident that Commerce will soon become the premier multi-product manufacturer in the country, with its unprecedented scale, efficiencies, and automation. The company's first suite of products will include edibles, tinctures, capsules, and infused pre-rolls, including our marmas, pebbles, chewies, high-burst verdure, and terp stick brands. This facility will have unprecedented automation and low-cost production capabilities, along with white label and private label opportunities. California is a state we're extremely excited about for multiple reasons, and the facility here was something that was planned to attack a market of scale and with automation that's far and above beyond what we've seen in the industry and across our portfolio in general. Our distribution and go-to-market strategy is based, pardon the pun, and we're chomping at the bit. This huge project for us has come into fruition, and the partnership conversations we're having on a daily basis to fully leverage the scale of this facility have me incredibly excited about the future. In that vein, We've signed an agreement with Navis, a top three distributor of cannabis products in California, covering more than 750 dispensaries on a monthly basis. We can't wait to announce the commencement of operations and commerce and look forward to the first edible tincture and vape products hitting California retail shelves in the coming weeks. In terms of our CBD business, we're making some progress but still not declaring a victory on the turnaround in this business. The team did a great job of cutting expenses even further and putting tight parameters in place with our new marketing vendor. The business is cash flowing and we're monitoring it closely as we continue to make incremental improvements in revenues. Before I conclude, I wanted to thank our entire Forefront team for their incredible efforts and commitment to making our company a success. Our president, Carlos Toscano, and COO Joe Feltham have been invaluable to me driving this business and making sure that all important details are taken care of as we position Forefront for accelerating growth. CIO Andrew Toot and EVP of Finance Jake Wooten have worn several hats on the finance, business development, and capital market side, and have served as a great compliment to this operations-focused CEO. And finally, I'd like to thank our CFO, Pete Rennard, who has come in on an interim basis and we have seen dramatic improvement in the timeliness of our financial reporting and systems. As a company, we're committed to ensuring our backup house is exemplary as our front of the house. So consistent with our mantra of my NICO focus on execution, we've set up operational bogeys and are knocking them down. Our really hard work in 2020 has beautifully set the table for a strong 21. And I'm pleased to report that our strong business momentum has continued through the second quarter. As we finish Q2, we are excited to add to this momentum with the opening of our Brookline location and turning on the project in commerce. We remain very comfortable with our previous guidance of system-wide performer revenues of $170 to $180 million and adjusted EBITDA of $40 to $50 million. We anticipate these numbers could have an upward bias as we move through the year. With projects falling into place, it also seems a good time to remind investors what we're playing for. We believe if we eat only what's on our license plate today, we have at least a $650 million revenue opportunity and a $250 million adjusted EBITDA opportunity on our hands. We have a desire to take our scalable efficiencies and go deeper into the states we have. With that, I'll now turn the call over to the operator to open the lines for Q&A.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions.

Thank you. Our first question comes from Neil Gilmer with Haywood Securities.

Please proceed with your question.

Hey, Neil. Thanks for joining us on a Canadian holiday here.

Yeah, yeah. Good afternoon. Happy to, and congrats on the quarter. You guys get your holiday next Monday, so I understand. Maybe I'd start with your 26% quarter-over-quarter growth sort of outstripping some of your peers. You know, was that largely driven through that, I guess, that 100%, I think you said, growth in Illinois? Or, you know, you felt that you just sort of outperformed across most of your state markets compared to at least, I guess, some of your peers that have reported so far similar Q1 numbers?

Yeah, I'll hand the call over to Jake Wooten to answer that one.

Yeah, no, I think your instincts were correct. It's exemplary performance from our Calumet City dispensary, which opened in mid-June, as Leo alluded to. However, there's also some incremental gains in our Massachusetts facilities as well. Washington was kind of consistent with what it typically has been for the last few quarters, and Michigan as well, and pure ratio is the same. So it's largely the Illinois dispensary opening and then some incremental gains in our Massachusetts facilities.

Okay. Thanks, Jake. This might be towards you again, Jake, but just on the gross margins, it looked pretty solid in the quarter. And then if I understand the comments with respect to Illinois and the ramp-up in production, they're having an impact on cost per gram. Fair to assume that normalized, you'd see even slightly higher adjusted gross margins. And the second part to that question would be, as you bring on your California operation

will that have a you know again a short-term impact uh on margins potentially as you just sort of absorb that into your portfolio yeah no great question without getting into two uh two detailed specifics uh we do believe there were a few hundred basis points that could have been had in the quarter with respect to gross margin had our illinois facilities been uh been able to harvest in the quarter and get some of that product in through you know through the calumet city expansion So that's, you know, with respect to that question, you know, in terms of California, you know, we're currently expecting our California margins to be relatively in line, you know, with what we're currently doing in our other states. So no material changes as we look to roll California online in Q2 and Q3.

Okay, maybe a final one for me, and then I'll pass the line for questions, would be just sort of if I take a look at the midpoint of your guidance on both rev When you're an EBIT guy, you get to sort of have between a 25%, 26% EBIT margin, 19% this quarter, and obviously with some of those impacts, I guess it seems to me that the bias would be towards the upside of that margin range just as you progress through the year and have those efficiencies come online. Is that sort of a safe way to, you know, safe perspective to have as you move into the second half of the year?

Yeah, Neil, I think that... Leo sort of said it best. We're really comfortable with where we are from a guidance standpoint, and we do think there's potential for upward bias as we move throughout the year.

All right. Well, thanks very much.

I appreciate the questions.

Thank you, man.

Thank you.

Our next question comes from Graham Kreindler with 8 Capital. Please proceed with your question.

Hey, Graham. Andrew, hi, guys. Thanks for taking my questions this afternoon. I've got two follow-ups regarding the previous set of questions here. I just wanted to start on the gross margin side of things. Do you disclose what the gross margin looks like on a system-wide basis as we try and assess both the revenue and the adjusted EBITDA just to bring that full circle?

Jake, do you want to hop in there?

Yeah, of course. Graham, we don't disclose it on a system-wide basis. As you know, the Washington financials, we cannot consolidate them under U.S. GAAP. So if you want to look at the financials on a standalone basis, excluding the Washington operations, you can remove the real estate income line from revenue and simply take a gross profit against revenue from sale of goods to kind of get you an understanding of what the margin is for the THC and I should say the pure ratios business as well. But the operations that we directly operate own and can consolidate in from a financial standpoint.

Okay, understood. And then with respect to discussing the potential for upward bias on the guidance, if I'm reconciling all the comments made on the call and in the Q&A, that would lead me to believe that there's really a lot of leverage that could be found on the gross margin side of things. You know, that's putting aside any potential shift or acceleration of trends that we might see that impact the top line. But, you know, is the expectation that from the fixed cost expense side of things, that's going to remain relatively flat throughout the year? Is that a fair assumption?

I think that is a fair assumption. And I think what you're also seeing is a greater proportion of our sales moving through the second half of the year coming from vertically integrated operations as we open our Brookline location. And as Calumet City continues to ramp up.

Got it. Understood. Then my last question here, just as you talked about the capital position and with $18 million in cash and a lot of the facilities reaching a point where they're more efficient or being commissioned in Q2 here. What does the capex balance look like for the remainder of the year? And if you could potentially provide it by what project that's being dedicated to, that would be appreciated. Thank you very much.

Yeah, I'll take that one as well. Where we stand as of today, as Andrew mentioned, we left the quarter with just under $18 million in cash on the balance sheet. And where we sit today, we have about $2.5 million of capex remaining for the year. plus or minus a couple hundred thousand for maintenance capex as projects arise. What you're largely looking at is $2 million of that being spent in the commerce facility and then half a million being spent in the completion of the Brookline location. The construction is largely there. It's just simply a catching up of those open balances. Okay, understood.

That's it for me. Thank you very much and congrats on the quarter. Thanks, Graham.

Thank you. Our next question comes from Eric DeLaurier with Craig Hallam Capital Group. Please proceed with your question.

Eric, how are you doing? Hey, thanks for taking my question, guys. I'm good. How are you, Andrew? Thanks for listening in. Absolutely. So congrats on the NAVIS agreement in California. Certainly exciting to have that distribution with such large capacity coming online shortly here in Commerce. I was intrigued by the white labeling comments and wondering if you could just expand a bit on sort of the market for white labeling opportunities there, how far along you guys are in with any discussions, if any, and just any sort of comment on that opportunity there and how we should be thinking about it. Thanks.

So I'm going to turn that call over to Leo, and he and Joe can answer that one.

Sure. I'll give it my first crack, and Joe, please fill in whatever I miss here. It's a great question. Getting our own brands and products onto the shelf is definitely priority number one for us, but as we take a look at what's going on in the market and as we continually have conversations with competitors and friends alike, we see that there's a large opportunity for white label and private label in terms of They're not being enough processing capacity online to handle bulk orders. We're also seeing opportunity and interest from big retail chains in having their own private label. And they're having trouble finding a one-stop shop that can produce them a variety of items and multiple SKUs deliver on time and deliver consistently. And our facility is purpose-built to make stuff like that happen. you know, as we go along and entertain different kinds of conversations, it's something that we're open to and something that we're definitely set up and ready for.

That sounds very exciting. Switching gears over to Massachusetts, could you talk about the revenue split between your first party and third party brands within your Massachusetts retail stores? I think you had a comment of your brands taking share there and We're just wondering roughly what your current split is and if you have the production capacity to sort of maintain that split with Brookline opening shortly here. And I guess just in general, any comments on how you sort of think of that ideal mix between first and third party brands would be great. Thanks.

Yeah, I think that's a good one for Joe Feld from our COO.

Hey, Eric. Sure. So right now, the mix is about 90% of our retail sales are our products. And sales at the retail level continue to increase. We have the capacity to support them as they increase. And that, of course, takes into account Brookline opening, right? And it's expected that 90% ratio is expected to carry over in Brookline as well. If we continue to receive inbound requests on a weekly basis and for wholesale into other stores, that's where we're maybe being a little bit more selective. No issue supplying our own stores. But we're going to just keep expanding our wholesale footprint in Massachusetts over the coming quarters. Great. Appreciate the call. Thanks.

Thank you. Our next question comes from Namin Daga with Hedgeye. Please proceed with your question.

Hey there, how are you? Good, how are you?

Great to have new voices on the call.

Thanks for joining in. Thank you. So I just had a quick question about the Commerce California facility. How are you guys going to be able to manage to have 10 times the, was it the capacity or efficiency of the current Washington plan if They're about the same size.

Go ahead, Leo.

Sure. Are you referring to the size of the facility?

Yeah.

The Washington facility is right around 40,000 square feet, and the Commerce facility is 170,000 square feet. So a little bit of a difference in size. OK. But mainly it's automation and efficiency. We've put in automation that's far beyond anything we have in Washington and really far beyond anything we've seen in the industry to date. Those efficiencies, automation and size combined allow us for that 10x capacity. Gotcha. Thank you.

And, Leo, maybe it would make sense to sort of hit anecdotally on, you know, pick a skew like a marma, you know, what the production out of our Washington facility is and what the delta would be in terms of output at a California if it were running on a shift.

sure i think a marmor or just any edible in general is a good one to make because the edible machinery that we put in commerce is you know our machinery that we're most proud of and that's the most highly automated so in washington in a single shift we have 30 people working in the kitchen that can produce about 3 500 finished 10 packs of edibles In that same single shift, the machinery and commerce with five people working the line can produce 30,000 to 35,000 finished 10-packs, whether that's a marma, a hard candy, or a chewy, just any edible that we produce.

Thank you. Thank you. Thank you.

There are no further questions at this time. I would like to turn the floor back over to Leo Gauntmaker for any closing comments.

Thanks. Just wanted to thank everyone for the continued support and for joining us on today's call. Have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful evening.