Cresco Labs Inc.
Q4 2021 Earnings Call Transcript

Published: 23 Mar 2022

[Operator:]

Hello, everyone and thank you for joining the Cresco Labs’ Fourth Quarter 2021 Earnings Conference Call. My name is Jemma and I will be the operator for today. In addition to the Cresco management team, Co-Founder and CEO of Columbia Care, Nicholas Vita will be on the line too for the live Q&A. We shall now begin. Thank you.

[Megan Kulick:]

Thank you. Good morning and welcome to Cresco Labs’ fourth quarter and full year 2021 earnings conference call. During today’s call, we will also discuss the company’s proposed acquisition of Columbia Care, which was announced this morning. On the call today, we have Chief Executive Officer and Co-Founder, Charlie Bachtell; Chief Financial Officer, Dennis Olis; and Chief Commercial Officer, Greg Butler, who will be available for Q&A. Prior to this call, we issued our fourth quarter and full year 2021 earnings press release which has been filed on SEDAR and is available on our Investor Relations website. These unaudited preliminary results for fourth quarter and full year 2021 are provided prior to the completion of all internal and external review and therefore are subject to adjustments until the filing of the company’s annual financial statements. We plan to file our corresponding financial statements and MD&A for the 3 and 12 months ended December 31, 2021 on SEDAR and EDGAR later this week. Along with our earnings release, a press release and investor presentation regarding the proposed acquisition of Columbia Care are available on our Investor Relations website. Certain statements made on today’s call may contain forward-looking information within the meaning of applicable Canadian Securities legislation, as well as forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995. The forward-looking information and statements may include estimates, projections, goals, forecasts, or assumptions that are based on current expectations and are not representative of historical facts or information. Such forward-looking information and statements represent the company’s beliefs regarding future events, plans or objectives, which are inherently uncertain and are subject to a number of risks and uncertainties that may cause our actual results or performance to differ materially from such forward-looking statements, including economic conditions, changes in applicable regulations, the possibility that the expected synergies and value creation from the proposed acquisition will not be realized or will not be realized within the expected time period, the risks of the businesses will not be integrated successfully, disruptions from the acquisition making it more difficult to maintain business and operational relationships, and the possibility that the acquisition does not close including, but not limited to, due to the failure to satisfy the closing conditions, including the receipt of requisite regulatory approvals. Additional information regarding the material factors and assumptions forming the basis of our forward-looking statements and risk factors can be found in our earnings press release and in Cresco Labs’ filings with SEDAR and the Securities and Exchange Commission. Cresco Labs does not undertake any duty to publicly announce the results of any revisions to its forward-looking statements or to update or supplement any information provided on today’s call. Please note that all financial information on today’s call is presented in U.S. dollars and interim financial information is unaudited. In addition to today’s conference call, Cresco Labs will refer to certain non-GAAP financial measures such as adjusted EBITDA and adjusted gross margin, which do not have any standardized meaning prescribed by GAAP. Please refer to our earnings press release for calculation of these measures and a reconciliation to the most directly comparable measures calculated and presented in accordance with GAAP. These non-GAAP financial measures should not be considered superior to or as a substitute for or as an alternative to and should only be considered in conjunction with the GAAP financial measures presented in our financial statements. With that, I will turn it over to Charlie.

[Charlie Bachtell:]

Good morning, everybody and thank you for joining us on today’s call. It’s a very exciting morning. We are pleased to share our Q4 and full year 2021 results as well as our truly transformative news, the proposed acquisition of Colombia Care. Q4 marked the completion of a fantastic year for Cresco Labs. We produced $822 million in annual revenue, representing 73% year-over-year growth and we maintained our position as the number one wholesaler branded cannabis products as well as having the highest per store revenue of any scaled national retailer. While Q4 came in below our expectations, which Dennis will discuss in greater detail, we believe these results were more market-driven than operational. In fact, we competed extremely well during the quarter holding or gaining market share in 7 of the 10 states in which we operate. In other words, we took everything that our markets were willing to give in Q4. A giant thank you goes out to the entire Cresco family for accomplishing what it did in the headwinds of the quarter. Operationally, Cresco Labs continues to execute regardless of the macro environment with a clear and focused strategy of building the most strategic geographic footprint and obtaining market leadership positions. As a cultivator, we are generating quality, potency and consistency at an unprecedented scale. As a wholesaler, we are delivering the best selling portfolio of branded products, driving traffic for our retail customers and delighting end consumers. And as a retailer, our highly efficient retail platform meets consumers where they want to be met, feeds back essential data and supports our wholesale channel. The combination of these efforts has afforded Cresco Labs the ability to go deeper than any other operator in the market to that matter. This brings me to our other incredibly exciting news this morning, the proposed acquisition of Columbia Care. This acquisition will combine an amazing footprint with proven brand, operational and competitive excellence to create a new leader in cannabis. On a pro forma basis, after planned divestitures, the combined company will be the largest cannabis company in the world by revenue, the number one wholesaler of branded cannabis products and will have the largest nationwide retail network outside of Florida and number two overall. That is before we start sharing our brand portfolio, cultivation and retail operating procedures or integrate into a unified data analytics and R&D team. Put simply, we believe the combined footprint and operational capabilities will lead to so much more than either company could achieve individually, the whole will be more than the sum of its parts. Now, let’s review three specific ways the acquisition of Columbia Care is synergistic and will lead to attractive sustainable financial performance

[Dennis Olis:]

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

[Charlie Bachtell:]

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

[Operator:]

Thank you. Our first question today comes from Owen Bennett from Jefferies. Owen, your line is now open. Please go ahead with your question.

[Owen Bennett:]

Good morning, all and congrats on the deal. Couple of questions, please. First of all, I just wanted to get your thinking around how you are thinking around the combined brand portfolio and which specific brands from Columbia Care has still any specific gaps in your portfolio? And then the follow-up will be could you just comment on any states where you may have to make some divestments for this deal to go through? Thank you.

[Charlie Bachtell:]

Good morning, Owen. Thanks for the questions. Yes, so as it relates to the combined brand portfolio, I think that’s one of the things that we are going to be working on and develop between now and the closing of the transaction. They have got some good brands over there that may fit very nicely in our portfolio, vice versa, states matter and the state consumer profile matter, so one of the things that we will be working on as we go forward. And as it relates to state divestiture, yes, there is going to be some states as we talked about in our prepared remarks because of licensing caps that we will need to evaluate divestitures. We think it’s a great opportunity for us to optimize operations in those states. And then clearly, proceeds from any divestitures can be very productive in future CapEx needs and also de-levering the business. So we think it’s a great opportunity. I’d also mention those stakes, as Dennis mentioned, our very sought-after and valuable states. So it’s a great thing we will be working on over the next 9 plus months here.

[Owen Bennett:]

Okay, great. Thanks, again.

[Nicholas Vita:]

Thanks, Owen.

[Operator:]

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

[Camilo Lyon:]

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

[Charlie Bachtell:]

Sure. Good morning, Camilo. And I’ll start this off, and then I’ll also invite Nick to chime in on this, too. New York is one of the more interesting states because we do have overlap there that would give us two of the 10. And we both have certain stages of developments in production facilities. We both have retail footprints. So I think that’s going to be a project and a process where we think about the optimization. There is a lot more that goes into that analysis than just square footage or building type. It’s also logistics. There is all kinds of factors that play in what area, what location of the state we would want to commit to. And then also, to your point, the end divestiture value as it relates to that. But I would ask Nick, if you’d like to contribute your thoughts there, too.

[Nicholas Vita:]

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

[Camilo Lyon:]

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

[Charlie Bachtell:]

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

[Nicholas Vita:]

Sure, Charlie, may I add something to that?

[Camilo Lyon:]

And all the best. Sure.

[Nicholas Vita:]

So one thing to keep in mind is that Charlie and I are both Co-Founders of our organizations, so you’re talking to the people who had a vision for a – the way a company develops from the very beginning, that has basically been continuous and has had a very high degree of continuity since day 1. That fundamental kind of connected tissue, I think, is what has allowed Cresco and Columbia Care to make acquisitions and successfully integrate them. We’ve obviously, through the due diligence process thought through a lot, have begun thinking to a lot of the issues. But just to reiterate what Charlie said, the human capital element and the cultural element, which often lead, are the two sort of most significant risk factors when integrating a business, are actually the two areas that I think were most important when we thought about combining in the first place. Meaning if we didn’t have cultures that fit so well together, right, the organizational design would be a much more complicated process. And if we didn’t have the skills on either side to recognize what our relative strengths and weaknesses were, then again, I think we would run into probably more problems. But the benefit here is that both of these organizations, I think, have really done a good job of finding a way to build the internal capabilities to sort of manage that process, and we will be doing it on a parallel path, and we will be doing it together once the close takes place.

[Camilo Lyon:]

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

[Charlie Bachtell:]

Thanks, Camilo.

[Operator:]

Our next question on the line comes from Vivien Azer of Cowen. Please go ahead, Vivien, you line is now open. Thank you.

[Vivien Azer:]

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

[Charlie Bachtell:]

Good morning. Vivien, thanks for the question. I think as we articulated, one of the things that we really liked about this deal is more balanced economics that we’re going to get through the organization. And that was both as it relates to states where we will have a more diversified revenue profile from the states that contribute to our overall P&L, which we love, right, less concentration in 2, 3 big states, but as we mentioned, 8 states contributing over $100 million in revenue in 2023. So that’s great. The other thing, too, is more channel balance. And as we’ve always talked about, our thesis, our core thesis always has been, still remains. The future of this is in the middle two verticals of the value chain, right? And that’s brands and distribution of brands on as many shelves as possible. But in the interim, balanced sort of approach and verticality are key during this building phase. So we like the balance that this larger profile gives us. Plus again, as you’ve seen, we’ve developed some strength in becoming a retailer over the last couple of years, too. And now Greg has some additional thoughts here.

[Greg Butler:]

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

[Vivien Azer:]

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

[Charlie Bachtell:]

Yes. Vivien, this is Charlie. I’ll take this one. I think that’s similar to the brand rationalization question earlier. I think we will do the same thing there on the retail side. Of course, we love the Sunnyside brand. We think it’s very effective, but we will be looking at this over the next 9 plus months from now until closing and even after to really develop a thoughtful strategy on a state-by-state basis as it relates to the branding of the retail flags.

[Vivien Azer:]

Understood. Thank you.

[Charlie Bachtell:]

Thank you.

[Operator:]

Our next question on the line comes from Kenric Tyghe of AltaCorp Capital. Kenric, your line is open. Please go ahead. Thank you very much.

[Kenric Tyghe:]

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

[Charlie Bachtell:]

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

[Kenric Tyghe:]

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

[Charlie Bachtell:]

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

[Greg Butler:]

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

[Kenric Tyghe:]

Okay. Thanks very much. Good luck.

[Charlie Bachtell:]

Thanks Kenric.

[Operator:]

Matt Mcginley of Needham, you have the next question. Please go ahead.

[Matt Mcginley:]

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

[Charlie Bachtell:]

Good morning Matt, Dennis is going to handle.

[Dennis Olis:]

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

[Matt Mcginley:]

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

[Dennis Olis:]

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

[Matt Mcginley:]

Okay. Thank you.

[Charlie Bachtell:]

Thank you, Matt.

[Operator:]

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

[Aaron Grey:]

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

[Charlie Bachtell:]

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

[Greg Butler:]

And I think from a step one perspective, the great opportunity for us is we know some great brands in California. FloraCal, for example, was just the top five brand in the market. So, being able to take our brands and bring those into stores is a huge opportunity. We always look at retail cautiously, too. We know that in the last – second half of last year. I think cultivation licenses grew 10x retail. So, that tells us there is a lot more supply coming online, which means price pressure is going to continue to come down, which means some of these retailers might be looking to exit that business as they are looking at their own pricing and what they have to do to compete, which gives us an opportunity to potentially pick up some complementary assets in Phase 2. But Phase 1 is our winning brands into stores is a really exciting new step for us, and then we will take it from there.

[Aaron Grey:]

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

[Dennis Olis:]

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

[Aaron Grey:]

Okay. Thanks very much for the color and I will jump back into the queue.

[Charlie Bachtell:]

Thanks Aaron.

[Operator:]

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

[Pablo Zuanic:]

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

[Nicholas Vita:]

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

[Pablo Zuanic:]

I understood that, Nick.

[Charlie Bachtell:]

I think that was well articulated.

[Pablo Zuanic:]

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

[Charlie Bachtell:]

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

[Pablo Zuanic:]

Okay. And one last one Charlie if I can. If you look at the Columbia Care brand portfolio, which brands from the Colombia Care portfolio would be like excited and rushing to start selling nationally through your network?

[Charlie Bachtell:]

Greg, do you want to handle that?

[Greg Butler:]

Yes. Pablo, I think as to the portfolio, again one of the reasons we have become the number one wholesaler brand is because of our portfolio approach of good, better, best and play across segments. And that’s why we have seen such success on brands like Cresco. On their portfolio, I think the way to answer that is we will look at that over the next couple of months as we continue to evaluate by state where there are tuck-ins of opportunities and where our portfolio isn’t reaching opportunities. So, I am not prepared to load any brand at this point. I think all of them will be investigated as we go and will probably be a unique-by-unique state assessment to see where we have these opportunities in that portfolio mix.

[Pablo Zuanic:]

Okay. Thank you.

[Charlie Bachtell:]

Thanks Pablo.

[Operator:]

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

[Scott Fortune:]

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

[Charlie Bachtell:]

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

[Scott Fortune:]

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

[Dennis Olis:]

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

[Scott Fortune:]

I appreciate the color. Thanks.

[Operator:]

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

[Charlie Bachtell:]

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

[Operator:]

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