Q3 2022 Curaleaf Holdings Inc Earnings Call
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Good day and welcome to the Shirley <unk> third quarter 2022 earnings Conference call.
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I'd now like to turn the conference over to Camilo Lyon Chief Investment Officer. Please go ahead.
Good afternoon, everyone and welcome to <unk> Holdings third quarter 2022 conference call today, we're joined by Boris Jordan Executive Chairman, Matt Darren Chief Executive Officer, and Ed Kramer, Chief Financial Officer before we begin I would like to remind you that the comments on today's call will include forward look.
Statements within the meaning of Canadian and United States Securities laws, which by their nature involve estimates projections plans goals forecasts and assumptions, including the successful integration of acquisitions and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward looking statements uncertain.
Material factors or assumptions that were applied in drawing the conclusion or making a forecast in such statements.
These forward looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. We undertake no obligation to update or revise any forward looking statements, whether as a result of new information future events or otherwise, except as required by applicable law additional information about the material.
Factors and assumptions, forming the basis of the forward looking statements and risk factors can be found in the company's filings and press releases on SEDAR and the Canadian Securities Exchange. During today's conference call <unk> will refer to non <unk> measures that we do not have any standardized meaning prescribed by IRS such as <unk>.
Adjusted EBITDA definitions of which may be found in our earnings press release. Please note that all financial information is provided in U S dollars unless otherwise indicated with that I'd like to now turn the call over to executive Chairman Boris Jordan.
Thank you Camilo good afternoon, everyone and thank you for joining us to discuss our third quarter results today I will touch on third quarter highlights discuss our international progress and provide an update on the regulatory front and then hand over the call to Matt.
I am pleased to report our third quarter revenue reached a record $340 million growing 7% year over year and up 1% sequentially meeting our guidance range of flat to up low single digits gross margin was 49% up 280 basis points versus last year and 50% year to date.
While adjusted EBITDA was 25% up 240 basis points versus last year, we generated a record $60 million of operating cash flow during the quarter and ended with $198 million in cash on the balance sheet.
Despite continued inflationary pressures on the consumer amplified by unexpected headwinds, it's Florida, and New Jersey that we faced in September we delivered a solid Q3 results.
For context, we estimate the arbitrary delay by regulators postponing, our Borden County conversion, coupled with the impact from Hurricane on our Florida retail stores.
Third quarter sales by $3 million to $4 million or one percentage point.
EBITDA by approximately one 5 million.
I am proud of the effort our team members to deliver these results in a challenging macroeconomic environment.
We continue to execute on our growth strategy in the third quarter as highlighted by our new product introductions, expanding our retail presence in Florida, Pennsylvania and by our German acquisition to 420 pharma, which firmly prepared us for the country's upcoming adult use legislation.
Since the end of the quarter, we closed on the landmark acquisition of strike one I expect will further strengthen our position in Arizona, Nevada, and Utah, <unk>, six new dispensaries and expansive product line and an extensive portfolio of production licenses with 65000 square feet of total canopy cultivation.
And the capacity to expand the 80000 square feet.
This strategic acquisition strengthens our already leading market position in Nevada, Arizona, and Utah and addition to a flagship location near the Las Vegas strip.
Also we are thrilled to have been approved for adult use sales in our new Jersey location.
In the state.
We opened for recreational sales on November one and.
And early indications are that this will be another strong store for us.
Further bolstering our market leading position in the garden state.
We achieved close to a 30% market share in the third quarter with just two stores and a robust wholesale business and expect this strength to continue as board and fab ramps up.
We are acutely aware of the economic uncertainty our customers are navigating as such we are taking appropriate actions to ensure we continue driving growth and margin expansion next year irrespective of the economic climate.
Our new leadership team has been assessing every aspect of the business for maximum productivity and efficiency gains to this point, we are taking the steps to rightsize our cost structure across all areas of the organization, we are tightening our belts, reducing store payroll hours and a limiting eliminating unnecessary expenditures.
While the U S economy is projected to see virtually no GDP growth next year. The U S. Cannabis industry is projected to grow 13% in 2023 accorded the headset.
Let's not lose sight of where cannabis is in its maturity curve I firmly believe cannabis is a multi year double digit growth industry with many more long term catalysts that will drive increased consumer adoption and pure leaf is at the center of it all.
Our growth prospects are further enhanced by our European strategy in Germany is forthcoming legalization.
Speaking of our international business on August month, we added another significant piece of our European business.
The German market via the acquisition of a majority stake in 420 pharma one of Germany's largest cannabis operators.
<unk> is a key addition to our international platform that we will leverage as we continue building out our vertical supply chain ahead of German adult use sales, which we expect will commence in 2024 with a strong brand known for high quality flower, we plan to take <unk> to the UK and across Europe as markets allow over.
Hi.
But our primary focus now is preparing for Germany adult use conversion.
On this topic, we are very encouraged by the movement, we're seeing from the German health Minister and establishing a baseline regulatory framework for which negotiations can begin.
The German chancellors cabinet approved plans to decriminalize recreational cannabis consumption the.
The importance of Germany, as a catalyst for the European cannabis industry cannot be overstated.
The population of 80 million people, Germany, as a $10 billion market and it is already estimated to be one of the largest medical market in Europe . We expect the adult use market, we'll be open to domestic and international suppliers of Canada, when the adult use program commences.
In the UK, we grew our patient count by 176% now enjoyed 30 to put the patient share the number one position in the country.
Our business continues to perform to plan and we as we build out this market by adding new patients leaning on the power of social media to drive awareness and leveraging our scientific research studies to educate inform the patient and the Doctor population.
While international remains a small part of our revenue story today, we are investing in the long term growth of Europe's candidates future now and expected to begin paying meaningful dividends in 2024 and beyond.
On the U S Legislative President announced last month, calling for a review of the current scheduling status with kind of a truly historic event not only for the candidates the industry before the country.
Im hopeful that the HHS Doj FDA learn what we've known for years. The candidates can help many people live better lives frequent pain anxiety addiction and sleep deprivation.
The ultimate impact of the cannabis operators and the industry at large has yet to be determined. However, it is undeniable that rescheduled catalysts play schedule III or lower would unlock massive potential for the industry.
The burdensome 200, 280 <unk> tax provision.
Would you removed U S capital would flow to the highest returning assets and the true benefits of the plant could be studied and applied for the betterment of both.
Perspective since 2021, we have paid a cumulative total of 208 million extra in taxes due to $202 80 and.
And for this year, we estimate to have to pay an additional $140 million more intuitive in taxes payable.
Over the last three years this amounts to nearly $350 million, an extra 280, <unk> taxes that we could have used to invest in the business and our communities for the benefit of all our stakeholders.
With respect to save back we are the closest we've been in Congress, passing most crucial piece of favorable cannabis legislation.
Im optimistic as ever about safety chances in the lame duck session, both Democrats and Republicans have put forth a tremendous amount of time and effort into crafting the REIT legislation necessary for the industry to thrive my team is in full sprint for the next two months to ensure the ball is carried over the goal line.
Regardless of outcome, we are not sitting idle.
We are exploring all available options with the exchanges, we have had constructive conversations with NASDAQ and the PSX regarding the recently announced transaction and are preparing for multiple outcomes. We're relentless in our efforts to explore every option available that can increase liquidity and shareholder value.
With each passing day.
Increasing mainstream adoption and acceptance of candidates by both American and public and our congressional leaders.
As we expect to see in Tomorrow's midterm elections cannabis is well on its way to becoming the United States next great growth industry and purely is positioned to lead.
U S citizens will cast their votes Tomorrow, and we believe the revolt resoundingly in favor of cannabis legislation.
Finally, a few comments.
Our new state in adult use catalysts coming next year for which <unk> is uniquely positioned to benefit.
There are five states with adult use cannabis.
Solid initiatives of which we are most excited about Maryland, North Dakota, given our already robust market presence in both states.
2023, we have two strong state catalysts in Connecticut, and New York, both of which combined represent a $5 6 billion market opportunity and purely could not be better positioned to serve customers. In these important markets. We believe Connecticut will have its adult use program kicked off in the first half of next year.
In New York, we are ready we have the largest legal market share in the state and we have just completed our facility expansion in preparation for the adult use program launch in September I had a constructive conversation with chairwoman remained right of the cannabis control board based on our discussion I expect adult use regulations will be released by the.
Second quarter, and I believe that the incumbent rose will be grandfathered into the program with a significant role to play in the adult use market is vertical operators with the ability to calculate profit and sell cannabis products.
It should not be confused with the guidelines released two weeks ago met for the card program applicants.
We are working with the OCM to ensure a successful launch for all market participants and a pathway for the state to meet its social equity go well.
While timing is still unclear, we could potentially see the states' adult use program worldwide and the second half of 2023.
Lastly, on our fourth quarter outlook and his team have been working diligent to accelerate our GAAP conversion timeline and now expect to report our fourth quarter and full year 2020 to result in GAAP one quarter ahead of plan.
I expect there will be a lot of moving parts in quarter four due to GAAP conversion for revenue we are planning to be in the range of 353 to 355 billion.
As we approach the final two months of 2022, we have much to be excited about at <unk> and many levers to pull to continue driving our business forward next year and beyond with that I'll turn the call over to CEO , Matt down Matt.
Thanks for us.
I'd like to start by talking about resilience.
Despite continued economic pressures all around US Canada is proving to be a resilient category with traffic trends continued to increase and our dispensary, even as many of our consumers see greater value options trade.
Breakdown among our mid tier product is happening while our premium offering is holding steady importantly.
Importantly, trade out is not occurring as evidenced by 7% quarter over quarter growth in transaction.
Demand for cannabis is sticky and we are meeting our consumers, where they are with the product and value proposition.
Fairly diverse geographic and channel revenue mix is proving to be a key distinguishing factor driving our performance under.
One it allows us to absorb state specific shock, while still enabling us to execute on our revenue targets.
Despite these headwinds we delivered 1% sequential growth.
Our global scale, our team members, our balance sheet, our access to capital.
These are the competitive advantages we have built for the express purpose of giving ourselves the flexibility to succeed under multiple economic and regulatory scenarios and these are the advantages that will lead us in our next leg of growth.
Speaking of growth, it's worth contextualize, what we built.
By the end of 2022 pure leaf will have grown revenue at a staggering compounded annual growth rate of roughly 105% since 2018.
Broad domestic rights across 22 States and 142 stores has led us to a point, where we are comfortably transitioning from the asset accumulation phase to.
So the asset optimization phase in our evolution.
Accordingly, we are at this juncture by choice not market for us.
For the most part we are in the states, we want to be and we have scaled accordingly, and as such we are nearing the end of our U S capital investment cycle, allowing us to allocate resources to further optimizing our operations.
Our strategy is laser focused on maximizing the opportunities in our core markets.
It is important to note and in these core markets. Our adjusted EBITDA margin was 30% in the third quarter.
While these core markets drive our business today, we're also taking a long term view on where candidates will be tomorrow by investing in Europe and competing in our investment markets.
Similar to last quarter, our investment markets constituted a 570 basis point drag on our adjusted EBITDA margins with international representing roughly one third of that track.
And our West Coast markets, we are deploying plans to increase profitability by closing facilities, reducing overhead and focusing on our lean sales and marketing structure driven by innovation. We are doing the work and while our strategic review is not yet complete we have a line of sight to return to profitability in these markets and we should start to see traction in <unk>.
Four.
This strategic focus centers on three key elements that will drive enduring market share gains improving margins and strong cash flow generation.
Operational excellence urgent execution in our one <unk> culture.
Let's discuss these in greater detail starting with operational excellence.
Particular focus of mine has been increasing our cultivation productivity and flowers train diversity, which can have an immediate positive impact on our business by driving increased traffic to our stores and demand for our products in both our retail and wholesale channels.
While at the same time boosting our margins.
I will share more about our position on flower genetics and breeding programs on our Q4 call in March.
To say I'm very excited for what's to come.
Another example is the technology investments we are making.
We continue to invest in our e-commerce platforms and this strategy is paying off with a record breaking quarter of nearly 2 million online transactions.
We are re launching our loyalty program to better leverage data and consumer insights.
Ross branding and marketing.
Also we are launching a new ERP that will give us greater inventory visibility across the organization and improve our demand planning capabilities, both of which will yield faster response times to demand changes, thus, leading the productivity and efficiency gains.
Urgent execution is critical to our future success.
Market dynamics change quickly in cannabis and we need to adapt and lead the market just as quickly.
This is why we are intently focused on R&D and commercialization of our innovation pipeline.
We are on pace to increase new product revenue, 75% year over year led by the national expansion of click select classic nano <unk> and.
And that space.
Our select essentials disposable Vape line is a great example of the team recognizing a consumer name and bringing in entry level solution to market and four months.
This product line is now in 11 states and selling loans.
Few other product highlights during the quarter include our premium grassroots diamond and fees pre rolls that we recently launched in California complemented by the launch of <unk>, our value line of flower and pre rolls in Massachusetts with seven more states on the west.
While it's only been a few weeks find has been completely incremental to our business.
Put some numbers around the launch and flower sales and increased total flower sales in Massachusetts by nearly 70%.
What's more fine has not impacted our premium grassroots flower sales whatsoever.
As Boris mentioned in his remarks, we are conducting a top down bottoms up assessment of our cost structure.
Our early actions have resulted in reduced payroll hours at retail and early reads on these cost mitigation efforts are positive.
As markets in which we have implemented these initiatives have not seen a change in revenue trend.
While we are still finalizing our 2023 budget, we are targeting at least $40 million in gross expense reductions next year.
We're becoming more productive with less.
In California, we are nearly complete with our restructuring efforts lingering pricing pressures continued in Q3, However, I believe we could be nearing a pricing bottom in the state.
After meeting with our California team and hearing feedback from our partners I am confident that the actions we took to rationalize our distribution and institute a streamlined supply chain and manufacturing model are driving improvements that will begin to materialize this quarter.
We have reduced our inventory refocused our sales efforts to our top accounts and introduced new premium products into the market.
The result has been a rave reviews on our grassroots diamond infused payrolls and more importantly, our select brand is experiencing resurgence with both dispensary partners and customers.
This is yet another proof point that when we execute our plan with strategic urgency.
Things happen.
For the company of approximately 6000 employees that has grown organically and through acquisition, creating a one purely culture has been top of mind since I took over as CEO two quarters ago.
Our culture is the foundation from which we will build consistent long term profitable growth.
It doesn't happen overnight, but we are making significant strides to inspire all employees across the organization to achieve their highest potential more.
More importantly, we are aligning towards one commingle understanding in each one of US has an integral part to play in the continued development of this industry and that we cannot do it without the collaboration of every team member across the organization.
We are seeing the benefits of the scale breadth and depth. We have created however, we are not taking any of it for granted.
A petition from our public and private market peers as well as the illicit market force us to get better and do more every day.
I can confidently say there is no company better suited to meet that challenge.
Yeah.
Moving on to state highlights.
New Jersey continues to be a bright spot for us growing 21% sequentially.
Our Belmont location remains our pinnacle store generating 16% growth from last quarter.
Remarkably this location is on pace to exceed $80 million in annual sales this year.
That's over $7 million of revenue per month.
Not surprisingly new Jersey is amongst our highest margin space.
That is why we are so excited to have received approval for adult use sales in our third store onboard in town.
We opened for recreational sales on November one.
On the product side, we continue to see success with our new product introductions are selecting antibiotics and select the central selling incredibly well.
In Arizona, we opened our Scottsdale store, which is off to a strong start.
The start of Q4, we also closed on the <unk> acquisition, which added two stores in Arizona and for Premier locations in Nevada.
We are particularly excited about the remodel plans we have in store for our new flagship dispensary near the Las Vegas strip.
This month, we will launch our find value flower and pre rolls in the Arizona market with more states to follow up quickly thereafter.
In Florida, we opened two stores during the quarter, taking our total store count to 52 in the state.
Sales were down less than 1% driven entirely by the dispensary closures due to hurricane Ian.
On the pricing front, we began reducing our promotional stance and have been pleased with the results thus far.
As expected sales initially dipped in the test markets, but quickly stabilized. However, gross profit dollars grew faster than the sales decline.
This is a particularly important development as we aim to bring higher premium grassroots flower to the Florida market next year that should drive our AUR and margins higher we can.
Continue to invest in Florida targeting a few more additional sensors to open before year end and a further expansion expansion of our indoor flower canopy scheduled to be completed in first half 2023.
The vertical sales of our own brands in Q3 was consistent with Q2 levels.
Given the absence of driving sales of our own brand portfolio, we have identified a significant opportunity to expand our vertical mix and three key states, Pennsylvania, Illinois and Arizona.
All of which are below our company average.
We estimate that improving the mix of our own product in these three states would add over 200 basis points to our margins. This is a primary focus of ours as we set our plan for 2023.
On the operation side.
We continue our process refinement efforts in order to become more efficient.
For instance, we.
We will be switching our packaging some mylar bag from boxes for our base.
This change alone will save us an estimated $3 million not to mention the benefit of improved labor productivity of our facility workers we.
We are also analyzing employing more automation across our cultivation facilities, where feasible and cost effective.
Similarly, we are assessing markets in which we can wring out excess supply where it does not mean, thus reducing costs, while also helping to stabilize market pricing.
The key messages that we are leaving no stone unturned.
Overall I am encouraged by the progress we are making across all aspects of our business.
And we are getting better at executing our objectives with purpose confidence and speed, but more work is needed to take our company to the I know we can reach.
Clearly has a tremendous opportunity to continue forging the path forward for candidates.
Both domestically and internationally and that is a challenge my team is eagerly embraced.
We take our leadership position seriously and we are committed to building a world class multibillion dollar global cannabis business.
I could not be more excited about our prospects.
With that let me turn the call over to our CFO , Ed Primer, who will walk you through our financials.
Ed.
Thank you, Matt I will now review, our third quarter results and provide an update on the fourth quarter trends.
Revenue for the quarter was a record $340 million representing quarter over quarter growth of 1% and year over year increase of 7%.
Retail revenue was $260 million compared with $225 million in the third quarter of 2021.
Representing 16% year over year growth.
Wholesale revenue decreased 14% year over year to $79 million, representing 23% of our total revenue.
Sequentially retail revenue was up 3%, resulting in our 19th consecutive quarter over quarter retail growth, while wholesale revenue declined 7% as a result of continued rationalization of our wholesale business and lower module states.
Looking at a few key metrics, we saw similar consumer trends carryover from the second quarter into the third as transactions were up 7%, partially offset by a decline in average order value of 6%.
As Matt noted earlier, our customers are increasing the frequency of their visits while looking for more options to stretch their dollars.
Our gross profit excluding the impact of biological assets was $165 million for the third quarter, an increase of 14% year over year from $145 million gross profit margin was 48, 5% compared to $45 seven in the year ago period sequentially gross margin decreased from $52 one two <unk>.
48, 5%.
Our gross profit margin net of add backs was 49 eight in the third quarter versus 52, three in the second down 260 basis points due to higher discounts as we worked through to clear through aging inventory and additional reserves for inventory rationalization.
SG&A expenses were $104 million in the third quarter compared with $108 million in the prior quarter and up $2 million from the year ago period.
The sequential decrease in SG&A, primarily reflects decreased salaries and professional fees, partially offset by investments in our technology infrastructure.
SG&A as a percentage of revenue was 36% in the third quarter down 150 basis points compared with 32, 1% in the prior quarter and year ago period.
Our third quarter SG&A included approximately $6 $3 million of add backs versus $5 7 million in the prior quarter.
Net of these add backs, our SG&A rate improved 150 basis points to 28, 7% of total revenue in the third quarter compared to 32 in the prior quarter as we are already starting to see the benefits of our cost reduction efforts.
Adjusted EBITDA for the third quarter was $84 million, a 17, 8% year over year increase sequentially, adjusted EBITDA decreased $2 million or two 5% adjusted.
Adjusted EBITDA margin for the third quarter was 24, 7% compared with 25, 5% in the second quarter.
The 80 basis point decrease in our adjusted EBITDA margin from the prior quarter was mainly attributable to the 260 basis point decrease in gross margin as discussed Marcia.
Partially offset by SG&A decreasing by 150 basis points for the reasons previously mentioned.
Our investment markets, including Europe impacted our consolidated adjusted EBITDA margins by approximately 570 basis points versus 550 basis points in the second quarter with California, having nearly been reset we should see an improvement in EBITDA materialized this quarter.
On the margin front, we continue to prioritize driving our vertical mix higher in our retail stores overweight retail revenue growth and high higher margin states rash.
Rationalized wholesale markets and lower margin states and tightly control our SG&A expenses while.
While the third quarter was impacted from a combination of pricing pressure in certain markets. The delayed opening of Gordon town adult use coupled with store closures in Florida from Hurricane Ian we achieved a vertical sales mix of 64% slightly below but fairly consistent with the last quarter and I am encouraged by the many.
<unk> for margin improvement in 2023.
Turning to our balance sheet and cash flow.
Our balance sheet remains strong with cash and cash equivalents of $198 million as of September 32022, which increased by $11 million over the prior quarter largely as a result of generating record positive cash flow from operations of $60 million.
Our outstanding debt was $599 million net of unamortized debt discount of which almost three quarters is not due until December 2026.
Net capital expenditures during the quarter were $39 million, bringing our year to date total of $99 million, our investments continue to be focused on expanding cultivation and processing capacity as well as strategically increasing our retail presence.
For the full year 2022, we continue to expect capex to be approximately $125 million.
Since we have almost completed our large scale capex projects in the U S. We expect our capital expenditures in 2023 to be substantially below the 2022 levels.
We remain focused on our cash position as well as generating positive operating cash flow for the year and beyond.
In fact for the nine months ended September 30, our cash.
<unk> from operations was a positive $71 million working.
Working capital improved by $3 million year to date and improved $7 million in the third quarter alone.
Excluding the impact of biological assets inventory was up $5 7 million. This quarter. It is important to note that we improved the composition of our inventory as we cleared through aged goods, which impacted our gross margins as previously mentioned offset by an increase meant to support new product launches store openings in Florida.
And Pennsylvania, and our third adult use stores in New Jersey.
As Morris previously mentioned my team has been working diligently to report our 2022 full year financials and gap one quarter ahead of our initial plan to prepare for this and a potential up listing to a major exchange we have bolstered our senior leadership team with the addition of Christine Taylor, our new Chief Accounting Officer, whom I am pleased to welcome.
Back securely with her 30 years of executive leadership, and accounting experience in healthcare and the gaming industry to heavily regulated markets and her prior role.
As SVP of finance at <unk>, Chris.
Christine will continue to bring rigor transparency and compliance to our financial reporting.
As I get to me more of the analysts over time, you will see that casual optimization as my primary focus to that end, we will continuously review the opportunities to reclassify operating expenses to cost of goods, where allowable and to maximize our tax savings and as such will begin to capture certain identified benefits in the near term.
Having nearly completed my first 90 days of pure leaf I'm thrilled to have joined the impressive management team Boris and Matt have assembled.
We've accomplished a lot in a short amount of time, but there is more to be done.
We are implementing tighter financial discipline across the organization to drive expense leverage and will continue to be laser focused on improving our operating results and cash flow generation.
Finally, I would like to provide some color on how our fourth quarter shaping up.
Given the uncertain macro backdrop, we believe it is prudent to plan accordingly, and as such expect Q4 revenue to be in the range of $353 million to $355 million.
Which is comprised of our current sales run rate to be down slightly from Q3, plus an approximate $18 million benefit from trike as that transaction closed just a few days into Q4 with the upper and lower bounds of the range I provided dependant on the adult use ramp up of our board and down store.
With that I'll turn the call back over to the operator to open the line for questions.
We will now begin the question and answer session.
Ask a question you May press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys.
Is it any time your question has been addressed and you would like to withdraw your question. Please press Star then two.
In the interest of time, please limit yourself to one question.
At this time, we will pause momentarily to assemble our roster.
Okay.
The first question today comes from Vivien <unk>.
With Cowen. Please go ahead.
Hi, good evening.
Thank you.
Morris you noted the headset outlook for 2023 at 13%.
You are not yet ready to offer specific 2023 guidance I think you referenced that that industry outlet I was curious how you're thinking about 2023, perhaps excluding trike as youre going to get a nine month benefit there, but on an underlying basis do you expect to be a market share gainer.
Yes.
We think that first of all we think Connecticut and New York.
Certain points of time next year, we'll actually start to sell in obviously, we have leading positions in both of those states. We think the Connecticut will likely be in the first half of the year in New York in the second half of the year that should give a very strong boost given our position in both of those states were in New York, We have almost a 50 share if you kind of our wholesale.
Business.
In Connecticut, where we have a 25% share we think that those will give a very strong boost we also think that our European business continues to expand.
And although its from a slow low basis, we do think that that will start to contribute.
To the to the growth numbers next year as Matt said, we also believe that we're seeing some small green shoots level small green shoots in California, we've taken our California business down dramatically this year to the point, where we virtually sold very little in the third quarter due to the profitability of those products with <unk>.
<unk> to see some of those pricing start to firm up a little bit in California, and as we ramp back up slowly we could get some growth out of California as well. So that's the background to our to our numbers.
The next question comes from Aaron Grey with Alliance Global Partners. Please go ahead.
Hi, good evening and thank you for the question.
So first want to go back to your prepared remarks, and talk a little bit more about international and your outlook for Germany. Some of the details on regulations from the health Minister, particularly I believe you said that you expect it might be open to both domestic and international supply. So lets get more color on that in terms of how youre looking at that particularly in terms of importing and some of the details at the health Minister provided.
So how do you feel like your life's best positioned, particularly with the majority stake that you guys. Scott from 420 pharma and how youre looking for that market to evolve in Germany, and then implications for broader Europe . Thank you.
So at the moment, we know that Germany is negotiating actively with Canada.
Importantly, the <unk>.
<unk> with import.
And the thing that Germany has stumbled with us, but you have to be you have to exit the UN Treaty. One now there are only two countries that have exited the UN treaty for cannabis and then opted back in but just exited for cannabis.
For Canada in Uruguay, so the the European producers until the European countries themselves.
Go through the process of exiting the UN charter they themselves cannot import into they can operate their own country for the imported from the EU now we fully expect the Portugal, Spain. All these countries will go through this process as Germany goes through it but to launch the program obviously, they have nowhere near end of capacity.
They basically at best can manufactured 15 tons of candidates domestically they need multiples of that in order to launch the adult use program, both Canada and org wide can import because they add back.
For Canada, the U S Treaty and we do know that the Germans have been very actively negotiated with Canada for a bilateral agreement to be able to import from Canada cannabis into the German market. So.
We do think that Europe will go away, we think Europe will be able to do as well, we think that will take six to 12 months, but we do think that at the launch of the program.
I'll have to depend on Canada, and domestic German production for that we however think that there'll be more than enough but.
More than enough capacity to be able to supply that market.
420, <unk>, which we acquired has very strong supply agreements from Canada and has been supplying their 15 share in the medical market from the Canadian market.
So we feel very very comfortable in our position as that program launches in January of 2024.
The next question comes from Matt Mcginley with Needham. Please go ahead.
Thank you.
As you noted in your prepared remarks, you generated $60 million in operating cash flow this quarter, but $42 million of that came from tax deferrals and inventory balances didn't didn't improve as that inventory. You noted you made some progress on that.
Some of that statement is that inventory still weighted to states like California, and Oregon in Michigan, where that oversupply might limit the ability to sell that product and how would you assess the risk of these inventory balances, resulting write downs in the coming quarters, just given what you've noted with sales guidance I guess.
Perhaps most critically will you be able to drop that inventory level into the fourth quarter and use that as a source of cash or is that more of a 2023 initiatives.
But we feel very good about our inventory levels, we did with <unk>.
Did sell a substantial amount of Av.
Older inventory insulin and up only very little of that came from some of it came from California.
And Colorado, but for the most part we had some older inventory, Massachusetts in other states and we made a decision that we wanted to convert that instead of losing it and having it write it off we wanted to convert it to cash that's what actually hit our gross margin in the third quarter down from over 50 level, we do anticipate gross margins being above 50%.
And.
In the fourth quarter.
And as far as the tax deferrals those tax the tax deferral would be a $30 million approximately tax reform, which was paid in October .
The next question comes from Matt Bottomley with Canaccord Genuity. Please go ahead.
Good evening, Thanks for taking the question just on the guidance for Q4 within revenue so called the mid point of $354 million. If you take your Q2 contribution add $18 million for <unk>, and then obviously border towns going too.
It will be a bit of a tailwind for Q4 as well it seems like theres a lot of ability to come in higher than that number. So I understand a lot of other markets are seeing pricing pressure.
And other things that are weighing on results like consumer inflationary pressures on consumer spending. So I'm just wondering if you could point out.
Some of the states markets or just the components that are going to lead to the headwinds.
That sort of get you to the range that you've provided and then any other color on the differences between the <unk> and GAAP, particularly to your margin on EBITDA. I know you are probably in the process of finalizing those numbers, but traditionally from a directional standpoint adjusted EBITDA.
<unk> always come in lower just given some of the lease accounting so any color on those two questions I ask it would be great.
So I'll cover the.
Well actually why don't you cover the.
The accounting the accounting issue and then we will answer the first question.
Sure look we're still in the process of determining the impact. So at this point I can't really put a number on it to be honest with you.
<unk> be able to communicate that with you guys. When we report our fourth quarter numbers, there will be a small small adjustments to EBITDA. We don't think it's going to be as material as it is.
Our outsized as one would think but we're still doing the work.
Okay.
The first part of the question was.
Regarding.
The others, where we're seeing some some pressure obviously, we're seeing pressure in Pennsylvania.
We obviously, you'll see pressure in California definitely in Colorado.
And so we do anticipate the market has been more difficult and so we're trying to be prudent.
We're guiding down slightly for our core business don't forget we closed.
The <unk> transaction in the first weeks of we lost several days something like four or five days.
Of the October month on the <unk> transaction that we can consolidate so we had to take a little bit of money off of that.
The board and town store.
We just we want to be a little bit prudent to see how quickly that store will ramp.
And so we're just trying to be prudent and we're anticipating that the core business before aboard in town and and.
And Tri Ed.
So it is going to be down.
Low single digits.
And therefore.
But if you add the sort of $18 million for <unk> on top of that and a little bit for board and Todd on top of that that's how we get to the number of 53 to 55.
<unk>, which is an app on the $3 40 that we did this quarter.
Your next question comes from Andrew <unk> with Stifel. Please go ahead.
Hi, good evening, thanks for taking my questions.
And then just thinking about new Jersey here.
You previously alluded to morgantown, potentially being the strongest store in your network.
But it seems like youre kind of being a little bit of prudence for expectations here, especially for the ramp.
I'm, just wondering what's causing your your cautiousness here.
Or is it and what's happening in the state overall in terms of ramp up and expansion.
And prior states when we see Rec turning online the first 12 months as a as a rapid growth period and it seems like this is a little bit slower than that so she could give a little bit of color. There. Perhaps this is supply related we need more production online to be able to supply these stores or is it something.
Yes.
Thank you Andrew it's a great question.
So it a little bit the macro answer as well, we've got more than enough supply with the largest supplier in the marketplace. There is no problem.
With Charlie and its suppliers.
We always said it will be a strong store, we've never said it would be the best luck, it's very difficult to beat.
The bellmawr store, the Belmont stores, probably one of the highest grossing if not the highest grossing store in the country.
Today.
The oldest store in new Jersey. It sits on the border, Pennsylvania. So it gets a lot of the traffic that goes across the border probably 30% of that stores business comes from Philadelphia, and so that is a very very strong store in our other two stores just could never meet those numbers.
However, the board just outboard in top stores as our northern stores closer to the more densely populated areas, we fully anticipate that to be one of our strongest stores.
In New Jersey, probably our second store after.
The bellmawr store, but it's going to take some time to ramp when you launch new stores are.
Opening day of cannabis those stores tend to ramp a lot faster because all the stores open up at the same time when you launch a stores into nine months into our programs launching eight months of Tau program. It takes time to educate the population of where that store is and don't get me wrong, We think thats still do very well, but we're just trying to be cautious to see how that store will.
Ramp and we're not seeing any issues of New Jersey, New Jersey has been a great market as Matt said, we grew that business over 21% quarter over quarter. So we don't anticipate any slowdown in the new Jersey market, but at this stage at this point in time I don't know if you are in regards to that.
So I would just add important town probably are best situated store for adult use in terms of parking access visibility of those types of things. It's also our belmar NR edgewater stores are relatively close to one another important town has a longer drive so we're not expecting any cannibalization coming.
From our existing two adult use stores. So we're very bullish on board in town, but we're also being I think conservative but the early ramp in the next couple of months.
The next question comes from Scott Fortune with Roth Capital. Please go ahead.
Great. Thank you this is stefan on for Scott Fortune.
Question is on track for closing on track how do you guys view, the wholesale retail mix in Nevada, and Arizona markets. Thank you.
Matt you want to take that.
Sure So very excited to get to try the acquisition close here at the beginning of.
The fourth quarter and <unk> got a really strong position in Nevada, where it's been since the inception of that market also really adds to our already strong position in Arizona, and Utah or bringing on a great team with trial as well as really strong market positioning.
They've done a great job of having a strong vertical presence of their products and brands in their stores. So we've got a really great opportunity to have.
I have a lot of synergies between our product mix as well as theirs and build on what they were already very successful app.
And combined forces here. So it's a great addition in three markets that we're already very strong in and that we are excited to add to our existing purely portfolio there.
The next question comes from Todd Cohen with <unk> capital. Please go ahead.
Hi, Thanks for taking my question I'm, just wondering if you could break down and a little more detail the $40 million of expected cost savings next year and maybe how much of that is in the cards line, how much will be in SG&A and in labor costs, specifically or any additional detail you can give on that thanks.
Hi, Matt do you want to take that.
I will take that long.
I appreciate the question. Good question, we are assessing that as we speak to that for next year's budget I can tell you that if you look at our SG&A savings that we saw in the fourth quarter we.
We expect that to sort of the third quarter I apologize, we expect that the ramp into the fourth.
Savings that we are looking for are going to be across the board, they're going to come at our Cogs line Theyre going to come in at our SG&A line a lot of.
Leverage that were trying to get out of our retail footprint, where we have reduced some staffing across retail we have run initial tests, we've seen very positive results.
Going forward with our productivity has significantly improved and will continue to leverage on now, but we are literally booking across the entire spectrum of our expense structure. So anything associated with those folks G&A and other areas, we'll all see some leverage into next year.
Jeff I would just add that I would just add that will accompany growth was fastest <unk> pads over the last four years.
Many businesses in my life, you do tend to hire more decided to have a lot of inefficiencies were now at the phase where we've done most of the acquired that we need we finished most of the capex that we needed to do to build out our infrastructure to supply products.
So we now are.
As Matt said to rationalization and I think that we're going to start seeing quite substantial cost savings across the board as we become much more efficient in the operations across all areas of the business.
The next question comes from Glenn Mattson with Ladenburg. Please go ahead.
Yes, Hi, sorry, I missed your comment for us on safe, but I am curious just a couple of six eight weeks ago or so I think confidence is growing that something would happen in the lame duck session.
Now there were a couple of days away.
And I think part.
Part of the caveat back then was barring some sort of significant crisis or whatever like the war getting worse or something.
We're at the point.
Were I don't think theres any situations like that I'm curious like the conversations you're having with that behind the scenes.
Different from from from what's been heard publicly or anything like that or just as your confidence kind of growing or do you get a little more cautious as you get closer to the potential.
Potentials for trigger for something to happen there.
All I can say is that we are leaving no stone unturned in Washington, we are having.
Okay.
10, or more meetings every single day, we've got numerous lobby firm's numerous people on the ground.
<unk> added pure leaf have been incredibly active.
With pushing this process forward, we actually recently got investors to join in that process and pushing this I believe we've never been closer to getting that piece of legislation Republicans and Democrats on the staff side are talking very very actively about space right.
Right now they haven't finished the negotiation yet we hope that they will finish over the next we need.
The next couple of days will be difficult because of the elections.
Seeing the result, but we hope that by the end of this week.
We'll get back to those negotiations and we hope very early into the lame duck session to have a deal and then the question is what's that what that's going to get attached to in order to get it through I personally think that it almost doesn't matter, whether it's a republican sweep of whether we ever split Congress I think the process has gone so far theres so much commitment on both sides.
At this point that I would be highly I would find it.
Highly unusual that we would get something.
I've been cautious to date I'm getting more and more positive. So we should get some however, I want to cabinets, Washington, you never know what can change.
<unk>.
It's not a guarantee by any stretch of imagination, but I can only say to everybody I've never seen more cross the aisle activity on a piece of candidates legislation in the Senate that were seeing now and I think that's an incredibly positive side I also want to remind everybody. We are getting more Republican senators with with cannabis programs right now.
Arkansas North Dakota, a lot of these states that are coming in I think we got five states I think we've got six senators that are Republican senators are going to be joining.
The Senate.
Into next year, So I think.
And they have and they're going to have adult use cannabis programs. So all of these five states passed that I think we're at 2425 adult use cannabis program in the country I think we've really got a lot of lot of.
Energy behind safe at this point in time that I'm very very positive on them.
The next question comes from Eric <unk> with Craig Hallum. Please go ahead.
Great. Thanks for taking my questions.
So you mentioned increased verticals nation in Pennsylvania, and Arizona among other markets certainly other msos implementing the same strategy and made these price pressures.
Can you comment on some of the early impacts youre seeing to the wholesale dynamics in those markets. What are you seeing a change in mix or limiting of number of doors or some other changes there.
And perhaps any changes to retail traffic pretty much just looking to get.
Any color on any second or third order impacts from the increased <unk> that you guys might be seeing or preparing for thank you.
Matt you want to take that.
Yes, so I think in.
In the markets, where you have large vertical players take Pennsylvania as an example, we're certainly seeing a dynamic where those that have scale in Alberta, Calgary and have the capacity to supply a large portion of their shelves are.
Capitalizing on that.
It's included in that to be able to assort, our stores with more of our products and brands in an environment, where it has gotten more competitive and and.
And can be challenging so I think that is one of those strategic advantages competitive advantages for those of us that have built out a lot of capacity.
That's part of the reason, we're so focused on innovation in our products and brands. So that we can provide a great assortment too.
To our customers across the whole portfolio of products and brands and why we talk about our new product innovations growing 75% year over year like that that's such a big focus for us to continue to be able to do that I think you have other markets like Illinois. For example that we're excited to get the new dispensaries open that market has been very ripe for more.
Dispensaries.
Beyond the iron five or so that have been in that market. So we are already well in front of those groups that are going to be opening in before the end of the year that are brand new wholesale customers, where we are.
We're gonna be capturing a good amount of shelf space, there and we're going to see many more of those open up in 2023, So I think in a market like Illinois, we have a lot of opportunity to continue to.
Go more vertical in our stores, but additionally, there is a great wholesale opportunity to grow there because we're going to see a lot of new wholesale customers coming online.
<unk>.
The next question comes from Spencer Hanus with Wolfe Research. Please go ahead.
Great. Thank you for the question.
If we can shift to Florida for a minute you mentioned in the prepared remarks that since you've pulled back on promotions <unk> seen market share hold just curious what gives you the guys. The confidence that that's going to continue over the long term here and then with the change in promos. How do you think your price gaps compare to the market share leaders in the state.
So look I think we've seen Florida, Florida in general get more promotional across the market over time and I think part of what we've done is continue to get more strategic with the way we are promoting and.
We're able to offer a great value and a great everyday value for those consumers that are coming in and are more value oriented, but we're also launching new innovative products like our libra.
<unk> are now selling in may have been concentrated form is doing tremendously well. We are really focused on continuing to launch new products coming out of our <unk> system. There in Florida. So we have more downstream products on the horizon. Those are the types of products that.
Our command, a higher price and and we were able to not be discounting.
As much there. So I do think we are finding success in continuing to.
Rationalize some of that strategy and as we continue to bring on additional capacity and new products in our pipeline I think it's something that we're going to continue to be able to build on and as we get some more stores in our pipeline open up here.
Entity.
End of the year and Q1 can you give us more of an opportunity that continue to test and optimize those things.
This concludes our question and answer session.
I'd like to turn the conference back over to Matt Darren for any closing remarks.
Well. Thank you everyone for joining us and we'll look forward to connecting again in March. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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