4Front Ventures Corp.
Q2 2022 Earnings Call Transcript

Published: 15 Aug 2022

[Operator:]

Good afternoon, and welcome to 4Front Ventures' Second Quarter Financial Results Conference Call. Today's conference is being recorded. At this time, all lines have been placed on mute to prevent any background noise. After the prepared remarks, there will be a question-and-answer session. I would now like to turn the conference over to your host, 4Front Ventures' Chief Executive Officer, Leo Gontmakher. Please go ahead, sir.

[Leo Gontmakher:]

Thank you. As a reminder, during the course of this conference call, management may make forward-looking statements that are based on current expectations and are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These results are outlined in the Risk Factors section of the Company's filings and disclosures materials. Any forward-looking statements should be considered in light of these factors. Please note a Safe Harbor, any outlook presented is as of today and management does not undertake any obligation to revise any forward-looking statements in the future. I'm joined on today's call by our Chief Investment Officer, Andrew Thut; Interim President, Karl Chowscano; CFO, Keith Adams; Executive Vice President, Brandon Mills; President of California Operations, Ray Landgraf; and our EVP of Finance, Jake Wooten. I'll begin today's call with the quick review of our thesis and strategy before providing color on the top level operational trends and milestones we achieved during the quarter. I'll then hand the call over to Andrew who will give a deeper look into our Q2 results and provide an update on our active start for the second half of the year before looking ahead, what we have in-store moving in early 2023. We will conclude with a question-and-answer session where the entire management team will be available for any follow-ups. At 4Front, we are guided by our simple thesis. After perfecting our high-quality, high-margin production capabilities in Washington State, we are replicating that operational excellence by implementing those SOPs in large cornerstone adult-use markets like California, Illinois, Massachusetts, and Michigan. Our belief is that the sweet spot in the cannabis supply chain is manufacturing low cost, high-quality production of cannabis consumer package goods at scale. As with any CPG company, 4Front stands to benefit as the cost of our ingredients, in this case, cannabis decline and margins become more . As we sit here today, we couldn't be more excited for how our company is positioned in this emerging industry. Our retail operations are performing at or above expectations across the board with additional customer counts, as we continue to raise the bar with product innovation and quality improvements. We believe we are poised to meaningfully accelerate the trajectory of our growth as we leverage our investments in the state-of-the-art automation and scaled manufacturing processing facilities in California, Illinois, and Massachusetts. Through this approach, we are poised to triple or quadruple the revenues of our company within our existing geographic footprint over the next three years. Our thesis is playing out in real-time. While we have made great strides in the second quarter, we have seen an acceleration in business trends in our growth markets as we reach the midway point of the third quarter, particularly in Massachusetts and California. The cannabis industry's unique challenges have not deterred our confidence in this enormous opportunity. In fact, the obstacles that many other companies are facing only serves to strengthen our conviction and our unique positioning in the U.S. cannabis landscape. With automation and scale in our manufacturing facilities, we can drive efficiencies and savings that nobody else can match. The existing $100 billion U.S. cannabis markets is shifting from the eliciting gray markets to state-licensed operators and despite inconsistent capital markets and an honorous state tax system and lumpy state rollouts, that trend should continue as customers demand safety and consistency in their branded products and states look to maximize tax revenues. While we are increasingly optimistic, we will see incremental cannabis reform this year. We remain focused on what we can control and perfecting what we do best. Manufacturing and cultivating high-quality products at scale and honing our strategy to significantly cut costs while enhancing product quality. This has resulted in one of the most nimble and diverse product lineups in the industry further insulating us against pricing pressures and ultimately benefiting our customers with a variety in price points they deserve. As a management team, we have been incredibly busy during Q2, overseeing the growth of our existing operations and advancing significant discussions with a number of potential partners and strategically attractive businesses. In California, confidence in our strategy continues to grow as we are seeing a ramp in sales and an expansion of the opportunity set we are seeing in the state. As a reminder, we are pursuing a four-part strategy in California

[Andrew Thut:]

Thanks, Leo. As discussed, our belief is that the sweet spot in the cannabis value chain lies in the low cost high-quality production of cannabis consumer packaged goods at scale. That's precisely what we've positioned 4Front for as a company and as a result, we are now witnessing the start of a significant leg of growth that will play out over the next 12 months, augmented by strategic and accretive M&A. Our retail locations platform-wide continue to outperform, maintaining or gaining share with increased transactions and in many cases, net sales despite anticipated pricing headwinds. In California, we are demonstrating our ability to enter the market with our proven and award-winning portfolio of products priced as much as 50% lower than the leading incumbents. We are doing this while maintaining very healthy margins, which we expect to improve as fixed costs are leveraged and our competitor's product dumping comes to an inevitable end. Because we started the year with a revenue base of zero in California, the pricing pressures haven't created grow over problem for us. And in fact, we are bringing our scaled low cost production to bear on our market where commoditization has largely already happened. California is the largest cannabis market in the world and the land of brand, while other operators are shifting operations away from the state, we are leaning-in – in building brand and taking share. As our statewide groups continue to grow, there are emerging and encouraging signs that the California legal cannabis industry itself will soon find some relief. A combination of factors, including the repeal of the cultivation tax, a crackdown on illicit grows and water usage, and the significant expansion of retail licenses all proved to be tailwinds. And this is all before interstate commerce allows our regional hubs to service neighboring states at some point in the future. Recent research indicates that there are currently about 1,045 active licensed retail locations as at the end of June, that's up from 750 in June of 2021 in Cali. The pace of new license issuing in the state finished the quarter at a blistering pace with a 111 new retail licenses issued in June alone. Prior to June, the previous record for a month in California had been a mere 31. If that pace continues or even comes close, it would make a previous estimate of 1,200 locations by the end of 2022 and 1,600 locations by the end of 2023 looked quite conservative. We are already seeing more and more repeat buying from our retail customers, improving our monthly and 90-day average branded repeat customers each month since March. All the while, our 90-day average wholesale customer counts has grown 50% since the end of Q1, so 277 locations. This month, we are already seeing net sales growth of 50% over July and 39% over the prior three month average and it's already our highest month of private label in bulk biomass sales. In Massachusetts, as Leo said, we are feeling great about how our business is performing despite price softness in that market. As a management team, we acted swiftly to improve quality, freshen the product assortment and be creative with promotions. The result has been a business that rebounded nicely into the end of the second quarter and shown nice momentum into Q3. Let me throw out a few noteworthy stats from last month to help illustrate our accelerating progress. In July, we saw the highest transactions per day of 2022 so far, July also saw the highest average ticket for all of 2022 so far, and that has continued into August. And by the way, our flower sales increased 80% in July and those over June and those strong sales trends has continued into August. With the ever-improving quality of our flower that is still working itself on to the menus, we are very optimistic about our continued progress as we enter the second half of the year. I reiterate that our model is a stepwise process adopted from our success in Washington. We are always analyzing what is selling and what isn't and adjusting accordingly. For instance, we recently retired the underperforming Pebbles hard candy brand in Massachusetts. While outperforming SKUs like Mini Budz shake are proving to be a sizable component of our growth in the quarter and in the most recent months. We are adapting a real-time to the ever shifting consumer demand and at each iteration, we further improve our efficiency in our bottom line. In Illinois, construction of our Madison cultivation and production facility remains on schedule. As we approach the final stages of construction of Phase I, we are experiencing some nominal challenges regarding the timing of electrical supply to the facility, but our teams there have identified contingency options for temporary power and scope phasing in the event that we needed. These challenges are not expected to influence the on-time completion of Phase I construction still expected in Q4 of this year. Meanwhile, we have great market penetration as it is, and are already selling into 90% of the retailers in Illinois. With a recent 185 new retail licenses coming on board, we are excited to expand those wholesale relationships even further. We project about 80 or so of those 185 licenses to come online within the next year, which is great growth for the market and holds promise that the growth can be sustained over the coming years. On Illinois, let me reiterate a point I made on last quarter's call. With only two open dispensaries out of an allowable 10, we have enormous room for growth. We expand our retail footprint in addition to expanding our wholesale presence. Let me take a minute to underscore the growth that Illinois can be to our story. In Q2, we run rated about 42 million out of Illinois between two retail locations and a small 9,000 square foot grow. Quickly eyeballing some of the other MSOs in Illinois, with large cultivation and production capacity and a full complement of 10 retail locations, I estimate that they were doing about $275 million to $300 million in revenue. With Madison coming online, the first box for achieving this kind of scale will be checked. The second box is buttressing our wholesale capabilities and capturing the upside by adding additional retail. So stay tuned there as we have a lot of unrealized potential in the state and we're just getting started. Now let me review the numbers for Q2. Systemwide pro forma revenue for Q2 2022 was $34.5 million, up 6% from the prior quarter and flat year-over-year. GAAP revenue for Q2 was $28.4 million, up 5% over last year and 9% sequentially. The increase is due to the increased revenue of the California's wholesale revenue as it ramps and portions of wholesale growth in Massachusetts as well. Q2 2022 adjusted EBITDA was $9.2 million, up 23% from last year, representing an adjusted margin of 27%. Continued growth of adjusted EBITDA and margins expected to persist through 2023 as the company's operations drive increased productions and higher sales volume without material increases to overhead. Our balance sheet leaving the quarters in solid shape. As of June 30, 2022, we had $6 million of cash on hand and $49.5 million of related party long-term debt, which doesn't come due until May of 2024. Cash balance was down about 2.5 sequentially due to anticipated closing, and integration costs associated with Island and an investment inventories, we looked – as we set the stage for our next phase of growth here. We continue to feel very good about our access to additional capital, given our longstanding partners, unique market position, and ability to produce results. As we execute on our strategy, our thesis continues to flex. We are continuously improving and actively introducing our brands, products and best-in-class SOPs into markets and growing skills successfully. We are adding new SKUs on a monthly basis, having developed and launched more than a dozen new products and product varieties in Q2 alone, which brings me to my final point. Our goal has always been to become a larger company. By design, it's how our model operates best, while we are of course, open to the right opportunity to be part of a larger enterprise, we will not compromise to do so. We will remain heavily invested in the continued creation of shareholder value by perfecting our low-cost production and manufacturing and proving our thesis time again. Everything we are doing today builds our company and grows our value in the marketplace while also position us to be the ideal merger partner as a standard barriers of automation and efficiency of scale. With that, I'll turn it back to Leo for some final commentary before we turn it over to Q&A.

[Leo Gontmakher:]

Thanks, Andrew. If something is up, we believe we found the sweet spot for outsized value creation via the low-cost, high-quality production of cannabis consumer packaged goods. We reiterate our belief that our current assets represent an opportunity for $650 million in revenue and $250 million in adjusted EBITDA, and we are confident we can drive sustained growth and capture a significant share of every market we earn. We are proving ourselves to be a major piece of the cannabis landscape and some of the most exciting cannabis markets in the country and we can't wait to share in our continued success as we move forward. We are excited about our brands and as always, I'm incredibly proud of our team and their dedication to providing consumers with a terrific user experience at a great price. I'm convinced that the next 12 months will demonstrate the power of our model at scale, paving the way for robust sustained growth in the long-term and value for our shareholders. With that, I'll now turn the call over to the operator to open the lines for Q&A.

[Operator:]

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question will come from Shaan Mir of Canaccord. Please go ahead.

[Andrew Thut:]

Hey, Shaan. How are you doing?

[Shaan Mir:]

Good. How are you guys doing?

[Leo Gontmakher:]

I'm doing well. Dog days of summer.

[Shaan Mir:]

Yes. Congratulations on the quarter and thank you for taking my question. I'll be quick here, but the first one, I was just hoping you could unpack the gross margin movement this quarter a bit. It looks as though it was down sequentially by quite a notable amount. So I'd assume this at least in part due to the onboarding of the California facility, which isn't as that scale yet. So there's likely some growing pains there. So if there's just anything that you could provide on what impacted the margin this quarter and how we should be thinking about it going from here? Is this kind of the new baseline or do you anticipate sequential increases?

[Andrew Thut:]

Perfect. Yes. I'll turn this over to our new CFO, Keith Adams and Jake Wooten, our EVP of Finance can tag team this one. Keith, are you on?

[Keith Adams:]

Sorry. I was on mute. Hi, Shaan, Keith Adams. As you stated, part of the margin pressure was bringing on the acquisition of Island, but also pricing pressure across the states, but we see margin improving back to where it was before with increased spending on automation, higher yields that we talked about, and as we start to get operations at higher scale, we'll absorb more of the fixed cost overhead. And so again, we expect the margins to resume to what you've seen previously or better.

[Shaan Mir:]

Okay. Thank you. And then just my next question. It's on the Illinois operation. So in Illinois, they announced the 185 new dispensary licenses a few weeks back. I was just wondering what you think or anticipate for the cadence of the new store opening and how that timing will compare to you bringing on the Madison facility? And then if you could just add, if you already started reaching out to some of those licensees to establish relationships or any sort of efforts that are underway to kind of get your brands in front of those new store operators. Just anything that you could provide on how you're preparing for this new wave of store openings in Illinois?

[Andrew Thut:]

Leo and Karl, do you want to take that one? Leo, you just want to start?

[Leo Gontmakher:]

Sure. Absolutely. I'll take a first kick at the can here. It's been a slow process getting these retail locations open in Illinois. We're doing the best we can to keep our ear to the ground on a local and on a national level to try to gauge when some of these stores will be opening. Our sales team, wholesale on the ground there is constantly in contact with new potential locations as they come up and contact information comes available and we feel very confident that we're going to grow significant wholesale, once Big Daddy comes online, as far as how many stores are going to open this year or next, it's just really hard to tell with the regulatory, but I can definitely say with confidence that we're all over the stores that are open and as things come around, we have full new packages to provide to the retailers, the buyers of the bud tenders to make sure that we get the full product suite on the shelf as quick as possible. Karl missed anything there?

[Karl Chowscano:]

Yes. Not really. I'll just add to it. We are actively pursuing not only arrangements where we can have a fair amount of shelf space for the new to open facilities, but we are also actively looking to acquire our own retail outlets plus the way in which Madison has been designed, we have built in the infrastructure so that we have great flexibility in order to turn on or turn off canopy depending upon what the wholesale market looks like. But at this point in time, as we look towards the end of the year, we're very confident we're going to be able to have relationships and/or through acquisitions in terms of Illinois region – with the Madison.

[Shaan Mir:]

Thank you. Appreciate the color there. And again, congrats on the quarter. I'll pass it on now.

[Andrew Thut:]

Thank you.

[Leo Gontmakher:]

Thank you.

[Operator:]

Your next question will come from Colin George of Haywood Securities. Please go ahead.

[Andrew Thut:]

Hey, Colin. How are you doing?

[Colin George:]

Good. How are you guys?

[Leo Gontmakher:]

I'm doing well. We're doing well. Busy summer.

[Colin George:]

Yes. It's a busy week in the earnings period. I'm asking the questions on behalf of Neal since it's a busy post market here. Yes. I just want to dive back into the gross profit and gross margin for a second here. If I'm looking at it on a dollar basis, it looks like the gross profit came down by roughly about a $1 million during the quarter, EBITDA was relatively flat and SG&A was relatively flat. Are there some one-time items that might have been in that the cost of sales that would've been backed out of EBITDA that could be a bit of a drag on it during the quarter? Or is it coming out of OpEx? Just trying to get a better idea of what the normalized levels were in this quarter.

[Andrew Thut:]

Keith?

[Keith Adams:]

Yes. I'll jump in. Yes, as you said, we had one-time both transaction and integration costs with the Island acquisition and just some of the other financing and M&A activity that we're doing. So when you back those out of the spending, we'll normalize back out to again where we think where we were before in gross margin and hopefully start to increase the EBITDA – the adjusted EBITDA also.

[Colin George:]

Okay. So some of those one-time costs would've been in the cost of goods on impacting gross margin in the quarter, and then the SG&A level right now with flat quarter-over-quarter is pretty much the normalized level?

[Keith Adams:]

Yes. And the gross margin getting the scale in the operation specifically in California and getting the higher yields will help us significantly too. So…

[Colin George:]

Yes. Makes sense. Just trying to reconcile back down to that EBITDA number. That's helpful. Thank you.

[Keith Adams:]

Sure.

[Colin George:]

And then maybe just one more for me, I’m diving a bit more into the Bloom acquisition. It sounds like another nice good brand add to your portfolio there. Is it essentially just the brand and the IP that you guys are acquiring? Do they have some facilities in outdoor cultivation or anything like that in the state already?

[Andrew Thut:]

I'll turn it over to Ray Landgraf and Leo to answer that question. Ray, you want to start?

[Ray Landgraf:]

Sure. Hi, Colin. Great to meet you.

[Colin George:]

Good to meet you as well.

[Ray Landgraf:]

The Bloom acquisition is an asset deal. And in addition to the assets of Bloom, we're picking on some equipment, some staff, some team and look forward to folding that into the portfolio here in the next coming months.

[Colin George:]

Okay. Thanks. Yes. So there is some sort of facility attached to that. And then I guess maybe just one last for me before I pass the line.

[Ray Landgraf:]

There are no facilities or fixed overhead attached to it.

[Colin George:]

There are no facilities attached to it?

[Ray Landgraf:]

No facilities or fixed overhead, no.

[Colin George:]

Okay. Thank you. Sorry, I broke up there. Okay. And then the last one for me just has been pretty topical in the sector over the last little bit. Was there any cashes or taxes paid during the quarter there that might impact the cash flow or that was just kind of getting deferred out into further periods right now.

[Keith Adams:]

This is Keith. We made a payment against one of the – we made a payment against a Q1 tax liability and the rest is being deferred at this time.

[Colin George:]

Okay.

[Keith Adams:]

And just to quantify that yes, a $1 million cash being federal tax liability and a little over $1.1 million in Massachusetts taxes as well, so a little over $2 million in cash taxes paid out in the quarter.

[Colin George:]

Okay. Thanks. That's all the questions for me. Congrats on the quarter and thanks again for taking my questions here. I'll pass the line.

[Andrew Thut:]

Thanks a lot. Appreciate it.

[Operator:]

Your next question comes from Howard Penney of Hedgeye. Please go ahead.

[Andrew Thut:]

Hey, Howard.

[Howard Penney:]

Hey, Andrew. How are you?

[Andrew Thut:]

I'm good man. How are you?

[Howard Penney:]

I'm doing well. I was hoping maybe you could speak to – I know you said you have access to capital. I was wondering if you could speak to what your needs are in Illinois that complete the manufacturing facility. And then what you think it might take for you to get – how much capital do you think it might take for you to get to the full suite of dispensaries? Thanks.

[Andrew Thut:]

Well, so Karl, on the – well, on the Madison dispensary, on the Madison build-out, we are – that is fully financed by IIP and we will have some equipment financing here as we move into the end of the year. So that is all accounted for. In terms of new retail locations that we're looking at Howard, a lot of those are likely to be stock deals or small license or license acquisitions, where we use a small amount of cash and maybe a little bit of stock. So our stock is something that people are – acquisition partners are very interested in given our level of operational capabilities and what they view is the upside in the industry and our company given our growth opportunities. So when we think of the main currency for all M&A is going to be stock. And we are highly confident that we can do accretive acquisitions here as we move into the end of the year.

[Howard Penney:]

Okay. If I can ask this…

[Andrew Thut:]

Did I answer your question, Howard?

[Howard Penney:]

Yes. You did. Thank you.

[Andrew Thut:]

Okay.

[Howard Penney:]

And if I could actually ask the like kind of the same question again, I guess, but in a different way. I think, Leo, you said you could triple or quadruple your revenue is under the existing asset base. If I've got those words correctly, I didn't write them down. And that doesn't require any capital to get there, so you could triple or quadruple your revenues with no additional – so could you clarify that now.

[Andrew Thut:]

Did someone jump in there? No. We are looking at – Howard, our feet are always moving. We've been very vocal about our desire to be acquiring, getting involved in retail and in Illinois. And we're very desirous to be in California as a retailer. And so to the extent that we do need any additional capital, we are feeling very good about the ability of our capital partners to expand our cash available through some debt instruments, but we don't think we need very much. And we also are at a point in our business where California is ready to flip cash flow positive this fall. And we think that we're going to be free cash flow generative as we leave Q4. So we have a lot of stuff that we want to do in this business. I think that our capital partners are very on board with what we're trying to achieve and level we're trying to achieve, and they're there to be supportive and opportunistic as needed.

[Howard Penney:]

Perfect, Andrew. Thank you so much.

[Andrew Thut:]

Sure.

[Operator:]

There are no further questions at this time. I'll turn the conference back to Leo Gontmakher for closing remarks.

[Leo Gontmakher:]

Thanks, everyone for joining, and we look forward to keeping you up-to-date on the progress of our growing business. Take care.

[Andrew Thut:]

All right. Thanks, everyone.

[Leo Gontmakher:]

Thanks all.

[Operator:]

Ladies and gentlemen, this concludes your conference call for this afternoon. We would like to thank everyone for participating and ask you to please disconnect your lines.