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Earnings Transcript for AAWH - Q4 Fiscal Year 2022

Operator: Good evening and thank you for standing by. Welcome to AWH's Fourth Quarter and Full-Year 2022 Earnings Call. I’d like to hand over the conference to your first speaker today, Rebecca Koar, Head of Investor Relations. Please go ahead.
Rebecca Koar: Good evening and welcome to AWH's earnings call for the fourth quarter and full-year 2022. The presentation that accompanies this call can be found on our website, www.awholdings.com/investors. Before we proceed, I would like to remind you that there are several risk factors and other cautionary statements contained in our SEC and SEDAR filings, including our annual report on Form 10-K for the year ending December 31, 2022, which we plan to file in the coming days. We will not review those risk factors and other cautionary statements on this call. However, we encourage you to read them carefully. Various remarks on this call concerning expectations, predictions, plans, and prospects constitute forward-looking statements or information. These forward-looking statements or information are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements or information reflect management's current view only. We undertake no obligation to revise or update such statements or make additional forward-looking statements in the future except as required by applicable law. References may be made during this call to future oriented financial information and financial outlook, all of which are subject to the same assumptions or assumptions, risk factors, limitations, and qualifications as forward-looking statements or information. While we believe that such estimates have been prepared on a reasonable basis, reflecting best estimates and judgment, the actual financial results of the company may vary from the amounts discussed herein. During today's call, we will be referring to non-GAAP measures such as adjusted gross profit, adjusted gross profit margin, adjusted EBITDA, and adjusted EBITDA margin as defined and reconciled in our earnings materials and the appendix of the presentation. These non-GAAP measures, as defined by AWH may not be comparable to measures with similar titles used by other companies. Certain information that may be mentioned during this call, including industry information and estimates, is obtained from third party resources, including public sources and there can be no assurance as to the accuracy or completeness of such information. Although believed to be reliable, management has not independently verified the data from third party sources. On today's call, we have Abner Kurtin, Executive Chairman; Frank Perullo, President and Interim Co-CEO; and Daniel Neville, Chief Financial Officer and Interim Co-CEO. With that, I'll turn the call over to Abner starting on Slide 4.
Abner Kurtin: Thanks Rebecca. Good evening, everyone, and thank you for joining our fourth quarter and full-year 2022 earnings call. 2022 was a challenging year in the cannabis space. The legal cannabis market topped 25 billion and is expected to grow at a 15% compounded growth rate through 2025. Furthermore, nearly 70% of American voters support federal legalization. But while the economy faced rising interest rates and inflationary pressures, many cannabis markets faced an oversupply of products resulting in significant pricing headwinds, compared to previous peaks. Massachusetts wholesale spot prices decreased by 56% year-over-year. Meanwhile, the average retail item in the United States was down 13% year-over-year. These adverse conditions combined with the [left out of] [ph] expectations from Safe Banking not passing has deterred investment in the Canada sector. That said, this is a growth CPG business in a market with the potential for 100 billion in sales as consumers and states convert from the [illicit to legal] [ph]. These businesses have significant first music mover advantage and the industry has the potential to become one of the most important adult use goods of our lifetime. 2022 was the first full-year as a publicly traded company and we continued the growth trajectory we established in prior years. We continue to successfully navigate this difficult industry and our numbers speak to the unwavering dedication and tenacity of our team. We started later in the game, compared to several of the U.S. multi-state operators, but we have leapfrogged the competition. We now rank sixth in overall adjusted EBITDA for U.S. operators and in 2022 we began to stand-out from the pack. We grew EBITDA faster than any of our peers year-over-year from the highest average revenue per dispensary, solidified our position as a top brand, and had among the most stable wholesale performance of the entire MSO landscape, despite a challenging environment. We are continuing to grow and move closer to positive cash from operations when many competitors are retrenching. We've achieved record revenue of approximately 406 million for the full-year, representing 22% year-over-year revenue growth. Our adjusted EBITDA increased by 17% to 93 million, representing a 23% margin. Most importantly, we are near generating positive cash flow from operations for the full-year of 2023. These are tremendous financial milestones and I'm extremely proud of the team for delivering in a top environment. Despite some of the aforementioned headwinds, we are still able to make significant progress during the year. We had access to capital through the debt markets, which allowed us to fund our growth and maintain liquidity. These funds enabled us to execute our growth strategy. In 2022, where we expanded our geographical footprint and cultivation capabilities and they will continue to support our 2023 initiatives. We maintain a strong balance sheet with no near term maturities and ended the year with 74 million of cash on the balance sheet. We continue to believe in the tremendous value that comes from achieving scale in existing markets. Furthering this will require continued discipline and opportunistic M&A. While other companies are shying away, we think building scale is even more important than ever. In New Jersey, we were able to be top operator in the state right from the outset of [adult use] [ph]. We grew our cultivation from nothing to 42,000 feet and opened in one of the most successful stores in the state in Rochelle Park. This illustrates our execution of our playbook to enter late stage medical markets before adult use, and we were able to generate similar success to our initial victories in Illinois in 2020. This type of medical to adult use conversion deficit [identified that] [ph] our future opportunities are in our existing medical states such as Ohio, Pennsylvania, and Maryland where we have a pending transaction. Ascend is well-positioned for the future with a considerable amount of our portfolio that we expect to benefit from near to mid-term adult use flips. As we continue to try to increase penetration in our core markets, we are looking at a variety of partnerships and distribution agreements to maximize wholesale and retail market share as new stores come online. These opportunities combined with disciplined M&A will drive our growth throughout the year. In 2023, we will shift from a period of hyper growth to focus on self-financing and being free cash flow [indiscernible]. Given the realities of the market today, all of our attention is focused on raising the bar for capital allocation and CapEx, improving our rates of conversion from EBITDA to cash from operations, and achieving positive cash from operations. In-light of this, we are changing our targets to 15% revenue and EBITDA growth for the full-year, and are expecting to generate positive cash flow from operations for the year 2023. This will be a major milestone for the company to achieve within 5 years since our founding in 2018. In 2023, we plan to fill our open CEO position. We continue to work with the search from Russell Reynolds to find the CEO with experienced scaling organizations. It is time for the industry to move from [founder led] [ph] organizations to professional operational management teams. We continue to review candidates and hope to have an update for you again during the next call. Meanwhile, we've been in good hands and are happy with the co-CEO roles that Frank and Dan have been billing. Their work has been critical to getting these assets open and will be critical to getting the company to cash flow positive this year. In addition to developments of the CEO search, we're making progress garnering support for [challengeable legality] [ph] of the Controlled Substance Act through the federal court system. We, at Ascend, believe the use of the CSA and is applied to the state legal business is unconstitutional. Many industries most notably online [indiscernible] have achieved legality and access to capital markets and exchanges through challenging the constitutionality of certain federal legislation. We think it is quite possible that cannabis follows in their footsteps. In fact, Justice Clarence Thomas had made comments supporting this viewpoint. He explicitly called the federal government's current approach of cannabis legalization as half-in half-out regime that simultaneously tolerates and forbids local use of marijuana where the contradictory and unstable state of affairs strains basic principles of federalism and conceals traps for the unwary. Ascend is working with a number of industry participants to advance legalization from a federal perspective. We expect to have more to announce in the coming months and we'll update you throughout the year on progress. We will not sit idle on the sidelines of this critical issue that could meaningfully lower the cost of capital and eliminate 280E taxation for the cannabis business. With that, I'll turn it over to Frank to review operational highlights from the quarter and then to Dan to discuss the quarterly financial results.
Frank Perullo: Thank you, Abner. Good evening, everyone. As Abner mentioned, I'm pleased to report that we delivered strong results in the fourth quarter and for the full-year of 2022, driven by the hard work and dedication of the entire Ascend team. Over the course of the year, we made significant progress in scaling our business. We expanded to Pennsylvania, our sixth state. Successfully launched [our use] [ph] in New Jersey, signed four acquisitions, grew cultivation capacity by 40%, and increased the number of open and operating dispensaries by almost 20% during the year. Last year, we began to see the evolution of our business as New Jersey flipped to adult use in several of our other markets began to get their sea legs. As the business has evolved, we're beginning to see a notable diversification of contribution to our overall EBITDA. This reflects our ongoing efforts to go deep within the states we operate and build businesses at scale as we expand into new markets such as New Jersey, Ohio, and Pennsylvania. On the retail side, we are thrilled to have achieved over 1 million transactions in the fourth quarter and continue to focus on providing the best shopping experience in the industry. Our efforts on menu optimization, associate training, in-store experience, and product diversification are paying off as we continue to achieve industry leading revenue per dispensary. Furthermore, last year, we set a goal to have 50% of our retail sales come from in-house or partner brands. And we are approaching this goal with a penetration rate of 47% in Q4 of 2022, compared to a 33% penetration rate in the same period last year. This [14 point] [ph] increase allows us to capture higher vertical margins, while still providing a diverse product offering for our customers. In Q4 2022, we launched the outlet model to provide customers looking for value with every day at low prices and now have four successful outlet stores across our portfolio. We recognize the importance of maintaining and growing our market share in some of the more competitive markets and are proud to be the first company in the U.S. to implement the everyday low price outlet strategy at select stores. On the wholesale front, 2022 was a challenging year in many markets. States such as Massachusetts and Illinois faced increased pricing pressure as the supply exceeded demand. Despite this, we were pleased to maintain our third-party wholesale revenue and meaningfully grow our gross wholesale sales. In response to these market trends, we launched our Simply Herb value cannabis brand in Illinois, Massachusetts, and New Jersey, as well as Michigan offering high quality products at an attractive price point. We have successfully broadened our product offerings by introducing edibles and vapes in New Jersey and Ohio and establishing strategic partnerships with brands such as Lowell in Illinois and Massachusetts; and Miss Grass in Massachusetts, Illinois and New Jersey. Our strategy for 2023 is to continue expanding our product portfolio to meet the evolving needs of our customers. Our focus on revenue is just one piece of the puzzle. We continue to focus on several cost savings initiatives to mitigate some of the pricing headwinds affecting our business. We are working to ensure our facilities are running as efficiently as they can through optimized production planning, labor strategies, and leveraging automation and technology. These programs have already begun to result in measurable improvements in efficiency, consistency, and quality. We are proud of the progress we have made over the past year and look forward to building on this momentum. Let's move on to Slide 6 to discuss updates that occurred in Q4 on the East Coast in more detail. We look forward to significant upside in 2023 from the full-year benefit of adult use sales in New Jersey. In November, we commenced adult use sales at our third dispensary in Fort Lee. The store had a slower ramp than our Rochelle Park flagship store, but is still performing well, compared to the rest of the state in AWH's portfolio. Also in the quarter, we doubled our production capacity in New Jersey by bringing online an additional 20,000 square feet of canopy for a total of 42,000 square feet. We expanded production to include edibles from our Franklin Cultivation facility providing us the full assortment of products and form factors throughout the state. We launched two brand partnerships in the state. In December, we brought Miss Grass, a female focused brand offering half brand pre-roll packs to the market. This product has already jumped to the number 2 selling pre-roll in the state in its second month since launch. Between Miss Grass and Ozone pre-rolls, we have the number 1 selling pre-roll portfolio in New Jersey. And in February of this year, we launched our 1906 fast-acting acting drops, which have already proven to be a hit in other markets and are expecting to be in-demand in New Jersey as well. We made tremendous strides in Pennsylvania during the quarter. We completed our Phase 1 cultivation build and planted 6,000 square feet of canopy, enabling us to produce supply for our current stores. In addition to our cultivation efforts, we also opened two highly successful outlet dispensaries in Scranton and Wayne. These two locations have served as proof of concept for our outlet model and have exceeded our expectations in terms of performance and customer satisfaction. As we look to expand our retail presence, we carefully consider each market and its unique characteristics, understanding that not all markets are suited for an outlet model. Cities like Scranton and Wayne present a more competitive landscape and therefore prime locations for this type of retail approach. Last to discuss on the East Coast is a definitive agreement where we recently signed to purchase four dispensaries in Maryland. As Abner mentioned, this transaction reflects our hallmark strategy to enter a late stage populous medical market on the verge of going recreational. We are hoping to close a transaction pending regulatory review later in 2023 and are excited about the prospects for adult use sales in a new state. Let's move on to Slide 7 to discuss our business in the Midwest. Beginning with Illinois, from the wholesale perspective, in Q4, we continue to face pricing headwinds in Illinois. As cultivators prioritize verticalization and bulk supply in anticipation of the social equity licenses coming online. We are maintaining our 99% store penetration in the state and are beginning to see some of those 185 licenses open. We are expecting 20 to be operational by the end of Q1. The company is working on selling into these new doors, as well as partnering with new license holders to put our products on their shelves. Furthermore, we are monitoring the exposure to our retail assets as we have faced increased competition from social equity licenses and the start of adult use sales in Missouri. 7% of our revenue is exposed to this increased competition from Missouri. We plan to offset this erosion two new stores we are opening and by increasing wholesale sales into social equity partners. We cautioned our offsets won't kick-in until the back half of the year, so we are preparing for cannibalization in the first half of this year in Illinois. On our last call, we mentioned that we commenced construction at our ninth retail location in the fast growing Chicago, Illinois suburb of Tinley Park, which we will plan to open by the end of Q2. We are still in the process of setting our tenth retail location, but hope to have the final store online by year's end. In Michigan, we completed the reset of our cultivation operations and are seeing strong quality and yield improvements. Today, we [soft opened] [ph] our eighth dispensary state in Grand Rapids, and we plan to celebrate the grand opening in the coming weeks. And finally, Ohio. We introduced Ozone vapes and edibles in the market in Q4 and saw an increase although small relative to other drivers in price per pound equivalent sold by adding a higher value SKU offering. Finally, we are pleased to announce that we plan to complete construction of the three Ohio dispensaries in our pipeline in Cincinnati, Piqua, and Sandusky toward the end of Q3. Once again, I would like to thank our employees that contributed to the success this quarter. And with that, I will turn it over to Dan to review the detailed Q4 financials starting on Slide 9.
Daniel Neville: Thanks, Frank. Good evening, everyone. As Abner mentioned, we are pleased with the company's record performance for the full-year. Total revenue for the year amounted to 488 million, representing 28% year-over-year growth. While revenue net of intercompany sales increased by over 22% year-over-year to 406 million. This growth was driven by increase in retail sales, particularly in New Jersey, and an increase in third-party wholesale sales in New Jersey and Massachusetts. The retail business would comprise 75% of revenue contributed meaningfully to this growth. Retail revenue increased by 32% to 306 million for the full-year. This growth was driven by the opening of four new dispensaries in East Lansing, Michigan, Fort Lee, New Jersey, Scranton, Pennsylvania; and Wayne, Pennsylvania, the conversion of three New Jersey dispensaries to adult use and the full-year benefit of consolidating two dispensaries we acquired in Ohio late last year. Gross wholesale revenue increased 22% year-over-year to 182 million as intercompany wholesale revenue was up across the board in New Jersey, Massachusetts, Illinois, Michigan and Ohio. Net wholesale revenue, which excludes intercompany sales, remained largely flat with revenue of 100 million for the full-year. This was driven by decreases in third-party sales in Illinois, but we faced pricing headwinds and allocated more of our product to support vertical sales being partially offset by increases in third-party sales in New Jersey, Massachusetts, and Michigan. Adjusted EBITDA for the full-year increased 17% to 93.2 million, while adjusted EBITDA margin decreased 93 basis points, compared to the prior year at 23%. The majority of the decrease was driven by gross profit declines in Illinois, which were partially offset by increased margins in Massachusetts, Michigan, and New Jersey. We also saw increased rent and compensation expense to support our expansion of operations. All-in, we are pleased with our full-year results, which were a testament to the hard work and dedication of the Ascend team. Let's move on to Slide 10 to discuss the Q4 results in detail. We had another strong quarter fueled by the onset of adult use sales in Fort Lee, New Jersey, the opening of two new dispensaries in Pennsylvania, and increased productivity in Massachusetts and New Jersey wholesale. As a result, our net revenue increased 1% quarter-over-quarter to 112 million. This was primarily driven by growth in retail sales in New Jersey and Pennsylvania, partially offset by lower wholesale sales in Illinois. In comparison to the prior year, net revenue grew by 27%, due to the opening of new retail dispensaries, conversion of three dispensaries in New Jersey to adult use, and an increase in intercompany and third-party sales, compared to the prior year. Our total retail revenue increased to 84.3 million for the fourth quarter, showing a 2% sequential increase, driven by the two retail openings. Notably, retail revenue increased by 30%, compared to the prior year. Q4 net wholesale revenue decreased 2% sequentially to 27.8 million, primarily driven by third-party sales declines in Illinois, which were partially offset by increases in New Jersey and Massachusetts. Despite sequential pressure, net wholesale revenue increased 18%, compared to Q4 of last year as there was a significant increase in units sold in New Jersey, [Mass] [ph], Michigan that was partially offset by lower average pricing. In Q4, adjusted gross profit increased 6% to 53.5 million with margins expanding 216 basis points to 47.7%. The expansion was driven by improvements in utilization and productivity in New Jersey as the Phase 2 cultivation became operational and AU sales commenced in Fort Lee, New Jersey. Our adjusted EBITDA improved 2% to 28.2 million in Q4, while margins improved 18 basis points to 25.1%. This increase was driven by gross margin improvements, being partially offset by increased transaction and compensation expenses, compared to the prior quarter. Overall, our strong Q4 performance was a testament to our relentless focus on execution and delivering value to our customers and shareholders. Let's move on to Slide 11 to review cash flows, the balance sheet, and our expectations for 2023. We ended the quarter with $74 million of cash and equivalents, 331 million in total debt, less deferred financing costs, and net debt of 257 million. We have 195 million fully diluted shares outstanding. In Q4, we used approximately 16 million of cash for operations, which included a $33 million cash tax payment for our 2021 tax obligations. Absent this payment, we would have generated nearly 17 million in cash from operations within the quarter. For the full-year of 2023, we are anticipating generating cash flow from operations inclusive of all tax payments and are laser focused on managing working capital and improving profits to drive towards this goal. During Q4, we invested approximately 20 million to support cultivation builds in New Jersey and Pennsylvania, as well as the Scranton and Wayne store openings Subsequent to the quarter, we amended the lease associated with our New Jersey cultivation to increase the tenant improvement allowance by 15 million. We expect to receive this cash by the end of Q1. In 2023, we expect to spend roughly $25 million of net CapEx as we build-out our dispensary pipeline and finish our build-out of our New Jersey cultivation. Cash from financing was $19 million – was a $19 million inflow related to a tax credit that we received during the quarter. We submitted for the credit in November and subsequently factored that receivable and received $19 million of cash in December. Looking ahead to 2023, we anticipate building on our robust dispensary pipeline and furthering our scale in our existing footprint. Capitalizing on the full-year of AU sales in New Jersey, deepening our relationships with social equity holders, particularly in Illinois and New Jersey, and entering our 7 state, pending the close of our transaction in Maryland, which is subject to regulatory approval. In 2023, we are focused on achieving 15% revenue and adjusted EBITDA growth, excluding the pending Maryland transaction and expect to generate cash flow from operations. We are proud of our industry leading growth in 2022 and strive to continue our upward trajectory in the years to come. I would like to extend gratitude to our investors, lenders, dedicated employees, and valued stakeholders. Your supporting commitment has been instrumental in driving our success. With that, I'd like to turn it over to the operator for questions.
Operator: Thank you. [Operator Instructions] Your first question comes from the line of Russell Stanley from Beacon Securities. Your line is now open.
Russell Stanley: My question. Maybe first just around Illinois, and your expectations I think for 20 new doors by Q2. Just wondering what your thoughts are on total new doors in 2023 and obviously the growth in the addressable wholesale market?
Frank Perullo: So, they're going slower than we expected. 20 new doors, the licenses were released late last year in the summer fall. There is a deadline that the state has given as of August. I would suspect due to the long timeline that these licenses were issued, I don't think, but I can't speak to the regulators and say that they're going to enforce that timeline. So, I do see some extensions in that in the future. But figuring that we got 20 by the end of Q1, I don't see it picking up pace. So, under a 100, maybe over 50, but generally speaking, we're seeing access to capital having a very big limiting factor in how many people can actually get their sites open, as well as the fact it took so long to get their licenses a lot of them lost real estate and had to start the process over again. So, we're seeing these trickle into the market. Not necessarily, as quickly as one suspected.
Abner Kurtin: I would also say that, you know I think the delays in Illinois combined with the difficult capital markets are just making us really hard as Frank kind of alluded to. We've decided to get more proactive. We're going to work closer with the existing licensees, look to provide financing, look to provide agreements and help them get open. We feel there's a lot of opportunity in the state and it’s imperative on the existing operators to, kind of step up and provide support to the new licenses.
Russell Stanley: Got it. Thanks for the color. That's really helpful. And then for my follow-up just around the sale of your [head of springs] [ph] of retail congrats on getting to 47%. Wondering what you think the upper limit is now, at what point do you risk or do you think you might be risking customer traffic through lack of variety over the margins?
Frank Perullo: The goal is 50%. I think as we get there, we'll reassess. Each market is different based on the products we offer, but the goal is 50% and that's what we're aiming for. So, I expect to see that by the end of Q1.
Abner Kurtin: I mean, the customer really wants good product quality and diversification that they're much less concerned about the grower of the flower. So, as we were planting more strains, we have more capacity as we can provide more diversity in our stores, we can grab a higher percentage. It's a little different in cases like edibles and certain vaped categories. Certainly wholesale leaders like in Illinois, like Cresco, GTI with Incredibles, Mindy's, and FloraCal. Like, you got to have those on the shelf, but we can do that and still capture a large percentage of the business through our own brands.
Russell Stanley: Got it. That's great color. I will get back in the queue. Thank you.
Operator: Your next question comes from the line of Matt McGinley from Needham. Your line is now open.
Matt McGinley: Thanks. How much of revenue impact did you see in your Collinsville and Fairview stores when adult use opened in Missouri in February? I think you said in the prepared remarks that that was like 7% exposure to stores that were closed in Missouri, but I think Collinsville had been doing – there's probably a little bit data, but it was close to 50 million in revenue. I mean, I'm curious how that looks now and am I correct in that that 7% seems low in terms of the overall exposure to the stores in Western Illinois?
Frank Perullo: Yes, great question, Matt. Thank you. As I mentioned, [7%]] of the business is exposed. Our Southern Illinois business was around 40% coming from Missouri and were down around 37% in the Southern Illinois stores. It's still early. We'll see if we can earn some of those customers back. But again, we're looking to open our ninth and tenth stores to mitigate that impact, as well as put products on shelves with healthy shelf space agreements for all of the license holders that are also opening up throughout the state.
Abner Kurtin: Yes. I would say, if we had opened our ninth and tenth store now, why does this happen? The effect would have been de minimis, but we have two great locations. We're excited about them out there coming on, you know later this year. And so there's a bit of a gap where we're facing that slight decline. We have another number of other stores in other states which are opening and doing great like New Bedford in Mass. But even in Illinois, we would be pretty flat if we had the ninth and tenth store open, but we got – we have great stores and their coming. So, it's not a huge delay. Also, I think there's a little bit of a misunderstanding about Missouri, I think, because the belief that pricing in Illinois is not competitive with Missouri is not true. First of all, Missouri is pretty inexpensive, but Illinois does have a lot of options. In particular, the tax on flower is only 10% in Illinois and there's a number of higher quality, lower priced flower than Missouri. On the vape and the edible side, yes, the tax is higher, but the price pretax is lower still in Illinois. So, we're somewhat – we're price competitive. It's just, as we expected, people want to shop close to them. For the Missouri customer who is 40% of our customer, they have a store that's close to them now. So, they're going to shop there. So, you know, that's, you know, it's entirely in-line with our thinking.
Matt McGinley: And on the EBITDA growth, you dropped the assumption from 30% growth in [2023] [ph] last quarter to I think 15% this quarter, what was the big driver of the revision of that assumption? And given you’re seeing revenues up 15, margins to be relatively flat, do you expect gross margin or G&A to be flat on a rate basis or do you expect to get some gains in one and losses in the other?
Frank Perullo: Yes. So Matt, the primary driver of that revision was related to Southern Illinois relative to our original expectations. It – to be earliest possible day that it could come on was February sixth. It came on February sixth. I think that was outside of the expectations. Most people were expecting April, May, somewhere around there as you've seen in states like New Jersey with the rollout these tend to get delayed, not open on day one. So that was definitely a negative variance relative to expectations and caused us to bring numbers down a bit. Some of that has been offset by better performance than inspected out of the new Bedford location that we opened. So, that's been a nice offset and I think a healthy addition to our [Mass portfolio] [ph]. But that has really been the driver. I think on the margin side of things, we do expect, I think, gross margin to take a bit of a step back relative to the robust performance we saw in Q4 in the first half of the year. We do have – we still are seeing some pressure on the pricing side of things as we ramp up in New Jersey and Massachusetts on the capacity, as well as the Illinois greenhouse. But that should kind of take a step back in the first half and then improve in the back half of the year. And then offsetting that, we do expect to see some leverage on the SG&A side of things as we grow throughout the year. So, those are, kind of the puts and takes on the margin side.
Matt McGinley: Okay. Thank you.
Operator: Your next question comes from the line of Kenric Tyghe from ATB Capital Markets. Your line is now open.
Kenric Tyghe: Thank you and good evening. I wonder if you could possibly just walk us through how much of the – we've spoken to Illinois at length, but how much of the performance in Illinois reflected some of the, sort of increased owned brand penetration of your competitors? I recognize you called out your brand were maintained at sort of positional ranking there in ozone. But how much of this is just a function of everybody looking to drive margins, increased own brand, versus just broader weakness in the wholesale market in Illinois ahead of these new licenses coming on?
Frank Perullo: Thank you. Sorry. Can you repeat the question? How much of the margin is related…
Kenric Tyghe: Yes. Sorry about that. The line just went dead there for a second. No, just with respect to Illinois, that performance in wholesale, how much of that is competitors increased focus on own brand penetration versus just the broader weakness in wholesale given current market dynamics and the delay in getting those new licenses, the new social equity licenses up and running?
Daniel Neville: Look, I mean, I think there is an upper limit on increased verticalization in Illinois. So, there is – you can only have 40% of your own product on a SKU basis on the shelves. And I think most of the operators in the state are operating at that limit or pretty close to the limit. So, I think it's less about the increased verticalization in Illinois, although there could have been a little bit of that on the margin and more so related to just the market getting a little more competitive. Now, there's not huge capacity additions that we're tracking in the market generally. And we do add the additional 185 doors that are coming online over time. But as Frank mentioned, I think us and others were prepared to selling to the social equity doors starting in Q4 and Q1 and the ramp has been slower on that side of things. And, you know, I'd say generally speaking, the doors on the social equity side of things, location dependent are probably performing a little bit under expectations for those operators.
Abner Kurtin: We saw a drop relative to either to other MSOs doing their own brand probably last – mid-last year, second or third quarter. Since then, we've been fighting just to maintain. And, you know, we have shelf space too. So, it goes both ways. They're looking to be in our stores. We're looking to be in their stores. We're trying to work to put the best product portfolio for our customers. It's been disappointing that we haven't gotten more stores open. You know, I think that when more stores open, there's going to be some cannibalization of existing stores well. So, it's not just a one-way positive, but we'll see what happens. You know, for us, we have this what we think will be a very nice top of two very strong stores, which will be 25% increase in our Illinois sales once they get over.
Kenric Tyghe: Thanks Abner. Makes sense. And then just with respect to Maryland and the potential timing on the start of adult use, your acquisition, they expect to close in the second quarter here. Adults use, sort of now expected July 1, is that not positive relative to your expectations or certainly a [soonest start] [ph] than most of the expected to adult use. How should we think about the impact of a July 1 start of adult use on the assumed close of your acquisition in Maryland?
Daniel Neville: Well, so we, you know, when we gave the guidance that is excluding Maryland. We did have, kind of in our internal models. We do have a de minimis contribution from Maryland in the model. I think unfortunately our experience with MedMen New York in that entire saga, we got things in the model that didn't end up actually closing. And so, we expect it to close in Q2. We expect adult use sales and all indications are pointing to a quick start to adult use on July 1. I think that is potential upside for us here, but we also didn't want to get too ahead of ourselves from a modeling or a guidance perspective because the timing of AU was uncertain and the timing of the close of this transaction is uncertain. And we've had some experience with acquisitions not closing in the past.
Kenric Tyghe: Thanks and appreciate it. I'll get back in queue.
Operator: Your next question comes from the line of Ty Collin from Eight Capital. Your line is now open.
Ty Collin: Hi. Thanks for the question. I wanted to follow-up with another question on Maryland. Can you maybe speak to how much capital you expect you'll need to invest in that state once the acquisition closes in terms of potentially refitting those stores and building [how to grow] [ph]? I think based on my read of the press release, there are four stores under two different banners right now and there is no associated cultivation assets. So, just curious what the plans are there and what you'd expect to invest?
Abner Kurtin: Yeah. So right now, we don't expect to spend much on the stores. I mean, obviously, we've got to get them up to stuff for adult use, but it's a small interior renovation. We don't have plans for a grow right now. We are – we'll always be opportunistic. We think Maryland is pretty well served on the biomass side. We're considering looking at a processing license or some kind of partnership so we can get our brands into the state. Unclear if we'll do a grow at this point. So, we don't really have much in the CapEx budget. That's part of the capital discipline. We've got to run things pretty tight. We don't have the funds to do that in 2023. As we move forward and we see what's out there, we don't [expect] [ph] the change.
Daniel Neville: Yes, I think order of magnitude, we're talking about like somewhere around $3 million for the retrofit of these stores to prepare for adult use, [indiscernible] them increased vault sizes, but the existing stores are in pretty good shape. To standalone buildings that are in pretty good shape, good sales floor. It's a lot of millwork expanding the vault size, re-slagging the stores themselves. One other consideration is, we're fully expecting [indiscernible] start to adult use sales. So, we got to figure out the Gordian knot in the puzzle of, you know, getting this work done for a refresh in time for the start of adult use sales on [7
Ty Collin: Okay. Great. Appreciate that color. And then switching gears, I wanted to ask a question on the inventory. So, it looks like it picked up another 5 million this quarter, maybe closer to 9 million if you account for the write-down that took place and obviously, kind of contributed to the cash outflow in the quarter. I sort of would have expected to see that trail off a little bit with New Jersey scaling up. So, I'm just wondering if you could comment on what was driving the build in Q4 and whether and to what extent we could expect to see part of that inventory balance monetized in 2023?
Daniel Neville: Yes. So, a lot of that growth is related to New Jersey. Remember, we turned on our – we doubled the size of our cultivation in early Q4. So, New Jersey is driving a lot of that growth, as well as a little bit of a build in Illinois, but the vast majority of it was doubling the size of the canopy in New Jersey and the increased inventory associated with that. We also had some additional store openings that we had during the quarter. So, carrying a little bit more inventory on the retail side of things as boxes grow. We still manage that pretty tight at 2 weeks to 3 weeks of inventory at the retail boxes, but as you open 4 additional stores in the quarter that does add up. On the inventory side of things, you mentioned the cash impact, but that write-down in Michigan was a non-cash write-down. It was related to a fair value adjustment related to the recoverable value of the inventory. Michigan, pricing in Michigan took down another step down late in the year, early in 2023. And so, we wrote-down the existing inventory to recoverable value, but that is a non-cash impact.
Abner Kurtin: We still have canopy coming online in the first half of the year, right? We've got [Mass] [ph] with some additional rooms and harvests. We have Michigan with some additional rooms and harvests, and New Jersey with some additional rooms and harvests. So, there probably is a little bit more to our working capital build and inventory build through the first half. That we expect it to flatten out.
Ty Collin: Okay. Thanks for that.
Operator: Your next question comes from the line of Andrew Semple from Echelon Capital Markets. Your line is now open.
Andrew Semple: Great. Good evening, everyone. Glad to hear the positive reception the patients had to the outlet model in Pennsylvania. I'm just wondering if you could, kind of quantify maybe how the stores would have ramped relative to your experience with medical stores in other states where you might not have been a first mover. If you can quantify some of that momentum in any way? And whether the pricing in the margins you're giving up is producing and that benefits earnings in that state relative to where you think you might have been, have you just followed the normal course strategy?
Frank Perullo: Sure. Thank you for the question. We're entering a pretty mature medical market. We're entering locations with 2, 3, 4, other dispensaries within a few miles. So, for us to grab share and get the customers excited about coming to our store and experiencing it, we've got to give them the best possible experience and the cheapest possible prices every day. Pennsylvania is a very promotional state, it's got a lot of menus, a lot of skews. So, what we're doing is curating an experience for our customers to get large quantities everyday low pricing. We're not necessarily as promotional as others in that we're giving the customers what they want every day. And trying to curate a menu of folks that want to be in our stores. They want to showcase their products, and get them to customers at an everyday low price. And I think when we open both Scranton and Wayne, it doesn't take as long to ramp up to where we're trying to get to, based on the fact that margins are lower than you would see when you're doing your normal [Keystoning] [ph], but we're grabbing more share and we're giving customers the experience they. And we're getting those repeat customers who are loyal to the brand coming to our stores every day.
Daniel Neville: Yeah. Andrew, we don't want to give away the secret sauce here, but I think in terms of the economics of the store relative to our original expectations, if you were to run it as a non-outlet model, we're seeing probably a 25% to 30% uplift in gross profit dollars from running this model relative to just running this as a traditional, you know, regular store in a competitive medical market. So, we're seeing good success in that margin that we're getting away is being more than paid for by the additional market share that we're seeing in these stores.
Abner Kurtin: Yes, I was going to reiterate that. I mean, we are very confident that the gross margin dollars in the outlet store is significantly higher than what it would be if we hadn't done that. And the customers love the [cheap weed] [ph]. It's a differentiated product mix. We're not going to have. There are going to be a number of competitors that don't want to put their products on our shelves at the lower price and that's fine. A lot of our customers are Walmart customers. Walmart taught us all how to do everyday low pricing and giving the customers low prices. And we're trying to do that. We think we don't have the data. We think we've gone from nowhere to become the number 1 store in Scranton. That's really, really unusual to do in a mature medical market. That is a highly, highly successful [indiscernible].
Andrew Semple: Great to hear that and not dissimilar from the experience we've seen in Canada. So, you know, great to see that momentum. Just wanted to switch gears and maybe talk about a, kind of flagship store, which would be Fort Lee. I just want to clarify the comments around that. I know you guys admitted that it was a little bit of under expectations the initial weeks. Could you clarify whether you're continuing to see revenues build there? Is it just growing more slowly than anticipated, but you continue to expect you'll hit reasonable run rates. Can you maybe spend a little bit more time elaborating on the dynamics at that store?
Frank Perullo: Yes, sure. Yes, we are seeing growth. We're seeing week-over-week and month-over-month growth and the store is performing very well. I think we had very high hopes for the store. I've not been let down with where I think the store is, and where it's headed. Since we opened for adult use sales, we've seen customers making that store there every day, every week store. And the way New Jersey is that those trade areas are, you could be within miles of each other, but you're going to shop where it's convenient for you. And Fort Lee is a particularly dense busy spot. So, we're seeing users who customers who are – were traveling to other stores, making that their store. And as much as we talked about over the bridge, coming over, this is a New Jersey store for the folks at Fort Lee and folks who are coming over to New Jersey to work as well.
Abner Kurtin: I mean, I think that, look with Rochelle Park being so successful in doing close to million dollars a week, there was maybe a little bit over optimism that Fort Lee would do those kinds of numbers, which is not, but it's still an excellent, excellent store, you know, in the top quartile of our portfolio.
Frank Perullo: Yes.
Andrew Semple: Great. That's helpful. Appreciate the additional color. Thank you.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.