Verano Holdings Corp. (PNK:VRNOF) Q4 2022 Earnings Call Transcript

Verano Holdings Corp. (PNK:VRNOF) Q4 2022 Earnings Call Transcript March 30, 2023

Operator: Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Verano Holdings Corp. Fourth Quarter 2022 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Julianna Paterra, Vice President of Investor Relations. Please go ahead.

Julianna Paterra: Thank you, and good morning, everyone. Welcome to Verano’s fourth quarter and full year 2022 earnings conference call. I am joined today by George Archos, Chief Executive Officer and Founder; Brett Summerer, Chief Financial Officer; Darren Weiss, Chief Operating Officer; and Aaron Miles, Chief Investment Officer. During this call, we will discuss our business outlook and make forward-looking statements within the meaning of applicable U.S. and Canadian securities laws, which are based on management’s current assumptions and expectations. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance and achievements of the business or developments in the company’s industry to differ materially from those implied by such forward-looking statements.

Actual events or results could differ considerably due to risks and uncertainties mentioned in our filings on EDGAR and SEDAR, including our financial statements and MD&A for the quarter and year ended December 31, 2022. In addition, throughout today’s discussion, we will refer to non-GAAP financial measures that do not have any standardized meaning prescribed by GAAP, such as EBITDA, adjusted EBITDA and free cash flow. Management believes non-GAAP results are useful to enhance the understanding of the company’s ongoing performance, but these are supplemental to and should not be considered in isolation from or as a substitute for GAAP financial measures. These non-GAAP measures are defined in our earnings press release and available on our website at investors.verano.com, which also includes the reconciliation of these measures to the most comparable GAAP financial measures.

Lastly, all currency is in U.S. dollars, unless otherwise noted. I will now turn the call over to George. Please go ahead.

George Archos: Good morning, and thank you for joining us. I’ll begin today’s call by highlighting our strong fourth quarter and full year 2022 performance, after which, I will give Brett the floor to review the financials in further detail. I will then provide my thoughts on 2023 and speak to the exciting path we see ahead of us here at Verano. I will then close with a discussion regarding our capital allocation plans, including providing guidance around certain financial metrics. I am extremely pleased with what we were able to accomplish in 2022. Throughout the year, we maintained agility in navigating our industry’s evolving environment, managing the business by diversifying our portfolio and improving efficiencies while aiming to protect the bottom line.

Our strategy since inception has been to build a self-sustaining business set up to thrive even under extreme market uncertainty, making no assumptions about changes to federal law. To date, the net result of these efforts has been the creation of what we feel is one of the strongest cannabis companies in the industry, with the belief that it is positioned to endure difficult macroeconomic conditions while generating cash flow and building long-term value. Turning to the results. I am proud to report that in 2022, we generated over $879 million in revenue, representing 19% growth year-over-year and $324 million in adjusted EBITDA, representing a 37% margin. New Jersey and Florida were the largest contributors to our growth in 2022, which Brett will speak to in more detail later.

Looking at the fourth quarter 2022. Results were in line with our guidance with revenue of $226 million and adjusted EBITDA of $79 million, representing a 35% margin. Fourth quarter retail sales were up 1.7%, driven by strength in our New Jersey operations as our final adult use location contributed a full quarter of sales, offsetting softness in Pennsylvania. We also had another quarter of improved vertical sell-through in our retail channels, increasing over 100 basis points sequentially to 47%, demonstrating the strength and breadth of our brand portfolio and SKU mix. Gross wholesale revenue for the quarter was down 6% sequentially, largely due to increased supply coming to the New Jersey market, which we anticipated, in addition to some price compression in Illinois.

Notably, the Verano product line was the number one brand in New Jersey for 2022 based on sales data according to BDSA. So, we are optimistic regarding futures wholesale growth once additional dispensaries in the state open. We have always looked to appropriately supply each market in which we operate, so in Illinois and Massachusetts, we have scaled back total output and optimized headcount as we’ve seen some recent oversupply in these states. Please note, we maintain the ability to ramp up production once we see the opportunity to put additional supply on shelves. Throughout 2022 and to date in 2023, we took decisive actions and made numerous investments to fortify our business, portfolio, organization and value chain. We continue to thoughtfully pace growth by adding 29 dispensaries during the year, a 32% increase in our retail footprint versus 2021, adding 21 in Florida, two in Nevada, two in Pennsylvania and four in West Virginia.

Subsequently, we added five dispensaries across Florida and Pennsylvania. Similarly, we continue to increase our cultivation capacity, mainly in New Jersey on the launch of adult use program and in Florida to support additional store count. In October 2022, we also strengthened our balance sheet by refinancing our debt in a rising rate environment, which included significant optionality by allowing us to prepay the first $100 million with only a $1 million prepayment fee. We expect to be able to decrease our blended cost of capital by leveraging our unencumbered real estate. In addition, we continue to enhance and expand our portfolio of strong brands. First, by launching Savvy, a value-tier brand, which was quickly embraced by consumers with a brand representing 15% of Verano flower sales in the fourth quarter on a unit basis.

On that note, we are very proud of how our brands have performed, for some, even with only a short time on shelves. According to BDSA, Savvy is now the number one top-selling large-format flower brand in Maryland after launching in the fall. Savvy holds a top five spot in Massachusetts and Pennsylvania and a top 10 spot in Arizona and Illinois. As we expand this product line, we anticipate Savvy’s popularity to continue to grow. We also launched BITS midway through the fourth quarter, which is a lower-dose edible line paired with a range of adaptogens. BITS is now the top 10 best-selling edible brands in a number of our key markets. Lastly, our Verano brand continues to perform well. FOR BDSA, Verano’s ranked as a top five brand nationally.

Of note, Verano’s brand performance is particularly compelling given that we only produce in seven of the 13 states included in this data set. In addition, we continue R&D as we can explore new brands and form factors. Specifically, we’ve seen success with our new line of solventless extracts and have plans for launches in additional select markets over the coming months. Relatedly, we also successfully launched a niche line of specialized infused pre-rolls at a premium price point in Illinois. We anticipate rolling this out in other markets throughout the year. In an effort to provide a deeper insight into our business, we want to highlight a few efficiency metrics that management utilizes to monitor and evaluate our business. For example, we closely track dollars per labor hour, which helps us determine how efficiently our retail outlets operate.

I am pleased to report that this measure has increased over 26% quarter-over-quarter. Similarly, we look at transactions per head at retail, which also went up 14% quarter-over-quarter. And our CPG facilities units produced per head increased 6%, while cost per gram decreased 9% sequentially. These metrics demonstrate our continued operational improvement. I am very pleased with what we accomplished, either while navigating a complex and challenging inflationary environment. And now I will turn it over to Brett to cover the financial results before I provide a more detailed outlook for 2023.

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Brett Summerer: Thanks, George. I’m pleased to deliver our solid financial results today. I’ll begin by covering full year results before drilling down into the fourth quarter results. Revenue for the full year increased 19% versus 2021 to $879 million, driven by the adult use New Jersey sales and increased contribution from Florida as we expanded our footprint. On a gross revenue basis, excluding intersegment eliminations, 72% of sales were derived from the retail business with the largest contributions from Florida, Illinois and New Jersey. The remaining 28% of sales were derived from the wholesale side of the business, with the largest contributions being from Illinois, New Jersey and Connecticut. Gross profit for the year was $423 million or 48% of revenue versus $331 million or 45% of revenue in the prior year.

On an adjusted basis, this was $517 million or 59%, in line with what was previously communicated. SG&A expenses were $357 million for the year or 41% of revenue versus $271 million in the prior year, or 37% of revenue, due to increased costs associated with the 29 dispensary openings, which can take up to six months to fully ramp up. On an adjusted basis, SG&A was $249 million or 28%. We continue to optimize headcount and expenses in our retail operations to strike a balance between prudent expense management and enabling continued growth. We have seen a decline over time from our Q2 peak in this cost as a percentage of sales. We had a net loss for the year of $269 million, driven by impairments to an Arizona cultivation license and to Pennsylvania and Arizona goodwill.

Notably, impairments were the biggest driver of our deferred tax liability decrease of approximately $50 million. Adjusted EBITDA for the year was $324 million or 37% of revenue. Moving on to the financials for the fourth quarter of 2022. Revenue was $226 million, up 7% year-over-year, driven by adult use sales in New Jersey and increased retail contribution from Florida store openings. Gross profit for the quarter was $103 million or 46% of revenue versus $109 million or 52% of revenue in the prior year, driven by increased discounting and cost increases associated with expansion activities. On an adjusted basis, this is $125 million or 55%, driven by the inventory reduction we spoke about on the last earnings call. Ultimately, we reduced inventory days by 17% quarter-over-quarter.

And while this is a drag on adjusted EBITDA, it has made us leaner and faster to pivot as well as freeing up some cash and helping us continue to build a stronger balance sheet. SG&A expenses were $81 million for the quarter or 36% of revenue versus $82 million in the prior year or 39% of revenue, driven by lower stock-based compensation and decreased M&A activities, offsetting increased costs associated with additional stores. On an adjusted basis, this was $62 million or 27%, in line with the lower target we previously communicated. We had a net loss for the fourth quarter of $216 million, driven primarily by the onetime impairments previously discussed. Adjusted EBITDA was $79 million or 35% of revenue. This quarter, Verano filed for a tax rebate known as the Employee Retention Credit.

This credit is worth $11 million net, and we qualified given that we met certain criteria for our operations during the COVID cycle. This credit is an offset to payroll tax, which is included in our adjusted EBITDA. So this credit is also included even though it is onetime in nature. Also if this credit was excluded, our adjusted EBITDA margin was remained above 30% for the fourth quarter and above 36% for the full year, even with the inventory drag we previously discussed. Turning to the balance sheet and cash flows. We ended the year with $85 million in cash and cash equivalents. Cash flow from operations for the year was $94 million. George will speak to our cash flow expectations in more detail later. CapEx spend for the fourth quarter and full year was $9 million and $119 million, respectively.

Net of PP&E disposals, this was $9 million and $113 million, respectively. Spend for the fourth quarter was slightly lower than our guidance of $20 million as some projects carried over into the first quarter. We still expect $25 million to $50 million in CapEx spending for 2023, spent largely on Florida and Pennsylvania retail expansion, Connecticut JV retail partnerships and minor cultivation projects. In addition to the deferred tax liability decreased discussed, other significant changes on the balance sheet include, the reduction of acquisition consideration payable to $18 million, a decrease of about $35 million. The remaining balance will be materially paid out this year. We continue to approach 2023 with a cost focus, and we’ll continue to opportunistically manage our cost of capital as we evaluate uses for excess cash.

Overall, I’m very optimistic about 2023 and look forward to the year ahead. And now I’ll hand it back to George to wrap up.

George Archos: Thanks, Brett. As we look ahead to 2023, we are confident that our business will build on the momentum and strength from 2022. We anticipate that our brands will continue to deliver value to patients and consumers across our strategically curated geographic footprint. This includes two states converting to adult use in 2023; Connecticut, which launched in January; and Maryland, which we anticipate to launch in the second half of the year. So far, we have seen a strong start with the adult use program in Connecticut, in line with our expectations. In the first four weeks at our Zen Leaf Meriden location versus the same period in the prior year, sales more than doubled, while sales of our in-house brands at Zen Leaf Meriden nearly quadrupled.

This speaks to our leading wholesale position and brand power resulting from the quality of our CT farm operations and products in the state. We continue to work with the local municipality for our other medical store to gain formal approval to convert to adult use. Additionally, we are making progress with our six social equity joint ventures, each of which plans to open a hybrid retail location. We are supporting each venture through the entire retail launch process from zoning to opening day, and expect our first joint venture to open its stores to adult use and medical consumers as soon as next month. As mentioned, Maryland is another state slated for a 2023 adult-use program launch. We are heartened by the progress the state is making, as recently as this week in advancing the adult use initiative, getting us closer to adult use sales.

Maryland’s medical program has presented challenges to vertical operators, including steep pricing reductions. Despite that, we worked to increase Verano sell-through by 13% to nearly 44% in the fourth quarter sequentially. And on the wholesale side, despite a difficult pricing environment, we increased revenue sequentially by nearly 6%. We have held a legacy presence since the early days of Maryland’s medical program, and we are well positioned ahead of the anticipated increased demand. With nearly 40,000 square feet of cultivation and four dispensaries in the state, we look forward to serving adult use consumers soon. The Pennsylvania, Florida and Ohio markets provide our portfolio with additional adult use upside as we are optimistic these states could legalize adult use sales within the next two years.

Taking a look more broadly, the industry continues to face challenges from a tax and banking perspective. While we are encouraged by the momentum surrounding a possible safe banking passage, we were disappointed this has not passed in 2022. However, this has not impacted our business. We have built the business to be self-sustaining and have never run the company relying on contingencies related to federal legalization. However, we will be ready to swiftly capitalize on any federal changes if and when they occur. And the impasse at the federal level has not prevented states from advancing state level reform, including, for example, New Jersey’s recent legislation around 280-E and Illinois’ progress on the same issue. Overall, we expect 2023 to be an inflection point for the industry and believe that it will be particularly difficult for smaller operators as they struggle to say afloat in the absence of banking or tax release and continued pricing pressure.

However, this is a potential opportunity for Verano to acquire operators in attractive markets at favorable valuations. Since the founding of the company, we have said, we would be painstakingly strategic about growing our footprint. That is precisely what we have done and what we will continue to do. And now we believe we are in a stronger position as we evaluate developing opportunities at attractive prices. Though we anticipate an appetite for M&A in 2023, we will also remain disciplined, patient and highly selective. Looking ahead, the number one priority in 2023 will be continuing to strengthen the balance sheet and focus on generating as much cash flow as possible. We understand that preserving cash is more important now than ever before given the burdensome tax structure our industry faces any difficult capital markets environment.

We have always sought to employ a thoughtful approach in deploying capital with discipline and balance, and we will continue to do so. Regarding CapEx. We have sought to appropriately build our footprint to maintain strong market position. While we spent $119 million in 2022, we made the decision late last year to significantly decrease our spend for 2023 based on internal assumptions of market growth and adult use activations. We are reiterating guidance of $25 million to $50 million of CapEx for the year and await further state-level legislative movement that would justify additional spend ahead of growth. I want to clarify and we will not set that CapEx at the expense of growth. So if we see opportunity, we will invest ahead of it appropriately.

But in the meantime, we are able to fully supply our markets with our current footprint. Given our significantly lower CapEx expectations and continued focus on efficiencies within the business, we anticipate generating between $50 million to $75 million of free cash flow for 2023. In addition, we plan on evaluating the best use of excess cash from an ROI perspective with an eye towards our cost of capital. Regarding our expectations for the first quarter of 2023, we anticipate flat top-line performance versus the fourth quarter. We also expect continued margin unfavorability for inventory rightsizing. However, as mentioned earlier, our focus is on the cash flow production of the company, and we at anticipate generating positive free cash flow and increasing our cash balance sequentially.

We look forward to sharing our results on our next earnings call, which is scheduled for May 10, 2023. The official announcement will be distributed subsequent to this call. With decades of experience building businesses for longevity, downturns are not new to me. And even with market conditions deteriorating in certain states, I believe the strength of our strategy is more apparent than ever. We do not need to exit any unattractive fragmented markets as we have had the wherewithal to avoid them from the start. We have methodically built today’s footprint, and we see the opportunity on the horizon to strategically build off this base. I want to thank the incredible Verano team for their efforts last year. We are reenergized and we are excited.

With that, operator, please open up the Q&A.

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Q&A Session

Operator: Thank you. We’ll go first to Matt McGinley at Needham.

Matt McGinley: Thank you. So my first question is on the gross margin, and the step down is about a nine-point quarter-over-quarter drop. Was that mostly the aging inventory reduction that you noted? And maybe more of a onetime pressure in the fourth quarter or the first quarter? Or is that 55% now the new run rate, given what you noted with the price decline in New Jersey and Illinois?

George Archos: Hey good morning, Matt, I’ll pass off to Brett.

Brett Summerer: Hey Matt, yes, so that decline is driven almost entirely by the inventory reduction that we had kind of messaged on the call last quarter. In terms of what does that mean for the future, we’re going to continue to manage our inventory and kind of dial it in to make sure that we’re supplying the right level of product to the market. Over the last years, we’ve had our new openings, and we started to understand the markets better. It was more focused on making sure we had the right supply so we didn’t shorthand anyone, but now it’s more dialing in. So, you’re going to continue to see us manage the inventory level. And there will be some impacts from that. Obviously, we can’t talk about what that will be, but you would expect we’re going to see some more of that over the course of the year.

Matt McGinley: Okay. And then the cash flow from ops, how much of the $94 million in operating cash flow that you generated this year was an increase in your income taxes payable balance? And we don’t have the full balance sheet yet, but it looks like you did have a step up in inventory in the fourth quarter. Is that the case? And if so, I guess, what drove that if you’re reducing that inventory, which is pressuring gross margin?

George Archos: Yes. So inventory did step down. You’ll see when we €“ when the 10-K comes out after this call. In terms of the taxes, we €“ it’s hard to say specifically, because obviously, we’re accruing at different levels this year than we did last year because our profits are different and our revenue is different as well. So there is some benefit of that. But of that operating cash flow, about half.

Matt McGinley: Great, thank you.

George Archos: Thanks, Matt.

Operator: We’ll move next to Aaron Grey at Alliance Global Partners.

Aaron Grey: Hi, good morning and thank you for the questions. So, I just want to continue on with the gross margin. Certainly, I understand the inventory €“ step downs inventory and how that might have an impact. But just talking about in terms of the brand portfolio, can you just remind us in terms of, obviously the increase you’ve had in terms of the value brands with Savvy having its success outside of this inventory rightsizing? And how do you think the brand portfolio evolves in the near term? It’s not like you expect Savvy to continue to increase outperformance. And the impact on margin, outside of the inventory impact that you’re having. Thank you.

George Archos: Hey, good morning, Aaron. I’ll pass off to Brett again on the margin.