Charlotte’s Web Holdings, Inc. (PNK:CWBHF) Q4 2022 Earnings Call Transcript

Charlotte’s Web Holdings, Inc. (PNK:CWBHF) Q4 2022 Earnings Call Transcript March 23, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Charlotte’s Web Holdings, Inc. 2022 Fourth Quarter Conference Call. This call is being recorded today on March 23, Thursday, 2023. I would now like to turn the conference over to Cory Pala, Director of Investor Relations. Please go ahead.

Cory Pala: Thank you, Julie, and good morning, everyone. Thank you for joining us for our 2022 fourth quarter and year-end earnings conference call for Charlotte’s Web Holdings, Inc. Our earnings release was issued this morning and posted on the Investor Relations section of our website along with our financial statements. Our annual 10-K report for the full 2022 year is also available and has been filed on sedar.com in Canada as well as in the U.S. with the SEC. Leading our call this morning is CEO, Jacques Tortoroli; COO, Jared Stanley; and the company’s new Chief Financial Officer, Jessica Saxton, who joined Charlotte’s Web at the start of this year. She comes to Charlotte’s Web following a career in finance at Anheuser-Busch InBev and brings both large and small company financial leadership.

On this morning’s call, we will review the financial results for the fourth quarter and full year and provide some context with respect to the business in the overall CBD category. We will then take questions from our analysts at the end of our prepared remarks. A replay of this call will be available through the next week, accessible via the details provided in our earnings release. A webcast replay of this call will also be available for an extended period accessible through the IR section of our website at charlottesweb.com. As a reminder to our listeners, certain statements made on today’s call, including so much as we may provide to certain questions, may include content that is forward-looking in nature, and therefore, subject to risks and uncertainties and factors which could cause actual future results of company performance to differ materially from implied expectations.

Such risks surrounding forward-looking statements are all outlined in detail with the company’s annual report on Form 10-K filed on sedar.com in Canada and sec.gov in the United States. In addition, during the call, we will refer to supplemental non-GAAP accounting measures, including adjusted gross profit and adjusted EBITDA. We should not have any standardized meaning prescribed by GAAP. Please refer to the earnings release contained in the Form 8-K that we filed this morning for a description of adjusted gross profit and adjusted EBITDA as well as a reconciliation of such measures to their respective and most directly comparable GAAP financial measures. And with that, I will now hand over the call to Charlotte’s Web Chief Executive Officer, Jacques Tortoroli.

Please go ahead.

Jacques Tortoroli: Good morning from Colorado, and thank you for joining our call. I’d like to start by introducing Jessica Saxton, our Chief Financial Officer to you. Jessica has been with us for just a few months and has proven to be a quick study. She understands our business and has demonstrated impressive insights in a short time, providing constructive leadership across our business. Jared and I very much look forward to partnering with Jessica as we move our strategic initiatives forward. This morning, we reported results for our fourth quarter and full year 2022. Before turning the call to Jessica for commentary on our Q4 and full year results, I want to highlight several points. 2022 was a difficult year for the CBD sector with disappointing sales as a result of ongoing inaction from the FDA on setting regulatory guidelines, continuing a marketplace of too many brands, isolate and Delta products, oversupply and inevitable consumer confusion.

As a result, we began to see retailers contract shelf space and distribution for CBD, incremental price promotions to spur consumer pull and relatively flat Google organic search for CBD. We retained our market share position — our leading market share position and leading retail velocities. Certainly, it was a tough year for Charlotte’s Web. Revenues declined over $20 million year-over-year. However, we maintained our market leadership across all key retail, e-commerce and brand metrics, which underscores the strength of our competitive position and the state of the overall category. E-commerce channel represents $2 billion or about 40% of the CBD market. Charlotte’s Web continued to operate the largest e-commerce business in CBD with only $51 million of revenue in 2022.

Revenues of $12.5 million were down 18.3% in Q4 due to lower traffic and higher depth and frequency of competitive price promotions and discounting. However, subscriptions increased 21% from a year ago and conversion rates were strong at 7%, it shows the opportunity we have by focusing on filling the top of the funnel by bringing more consumers into our brand ecosystem. For the full year, subscribers represented about 35% and of our e-commerce revenues. Our #1 challenge in turning around revenues remains bringing new consumers into our e-commerce and social channels. While we have initiatives for better returns on paid and earned media, this is where our MLB partnership comes in. On October 11, on the back of the announcement and about $30 million of earned media throughout the quarter, we saw traffic increases.

We also saw new consumers buying our NSF Certified for Sport Daily Edge product, also buying other CBD products on charlottesweb.com. Retail channels, where we compete in, represent about 25% of the CBD market or about $1.3 billion annually. We continue to lead in retail despite a $3 million year-over-year decline in revenues to $6.4 million in Q4 and $23 million for the full year. Our sales to food drug mass retail were down 10% year-over-year, while the total category in these channels was down 12%. As a result, we held 19% and 18% share in retail unit value and volume, respectively, number one market position. Distribution losses and price promotions were the principal drivers of year-over-year revenue declines. In the natural channel, our Q4 sales were down 14% year-over-year, while the category was down 19%.

As a result, we gained 3 points in distribution. Returning to the MLB partnership. With a full baseball season in 2023 beginning later this month, — we’re encouraged that the combination of MLB’s 180 million or so fans, our NSF broad-spectrum products, Jewel Event activations and a new CW e-commerce platform later this year are all levers in growing the top of the funnel. Once consumers are in our ecosystem, they stay with us across their journey becoming loyal repeat purchasers and subscribers driving strong conversion, AOV rates and ultimately meaningful lifetime values. In the coming weeks, to coincide with the start of the MLB season we’ll be announcing a strategic decision to launch a lifestyle brand of NSF Certified products targeted for millennial and Gen Z consumers in valuable cultural verticals to drive our larger growth business vision.

This is the perfect time to bring this brand to market, backed by the amplifier of MLB, including the iconic MLB logo on packaging. Brand will soft launch with one product on our e-commerce platform in April with further products launching on e-commerce and retail this fall. We’ll provide a lot more color on this during our next earnings call. Jessica and Jared will provide more color in her remarks, and I’ll close with a ’22 wrap-up as we progress into 2023 before opening up the call to our analysts for questions. Before I do that, let me turn the call over to Jessica for a review of our Q4 and full year financial highlights. Jessica?

Jessica Saxton: Thank you, Jacques. As noted by Jacques in his opening remarks, I’ve recently joined Charlotte’s Web from Evergreen Ingredients, an innovative sustainability company owned by Anheuser-Busch, where I gained valuable venture experience as their CFO. This, in conjunction with my experience at several world-class organizations, provides me with the unique skill set to blend the nitty-gritty aspects of entrepreneurship with the financial expertise and acumen of a successful global market leader. I am thrilled to bring my experience to the CBD market leader and contribute to its ongoing commitment to forwarding industry, advocacy and most importantly, delivering consumer needs. I came to Charlotte’s Web as a strong believer and authentic user of their products.

While CBD has certainly had a beneficial influence on my well-being, my decision to join Charlotte’s Web was also driven by a strong personal and professional connection to the company’s mission. It is an honor to be part of a company that adheres to B Corp principles, which include prioritizing the health of our planet. I have a strong passion towards sustainability. And as someone in finance, I understand the significant role we can play in creating sustainable solutions that will transform the way we do business. Ultimately, it is clear that our health and the planet’s well-being are strongly intertwined. I am aware of the obstacles that the CBD market faces, but I am optimistic. I believe Charlotte’s Web is the best positioned in terms of brand recognition, trust and loyalty, but also in terms of quality, IP and capabilities.

Along with this, our safety data and certifications are industry-leading. Before I take you through a high-level review of the financial results, I would like to review four key accounting items that impacted Q4. Firstly, in the fourth quarter, due to pending regulatory changes in Colorado, it was determined that the useful life of certain hemp biomass inventory would not meet long-term product specifications and labeling requirements. Jared will speak in more detail about this. Hemp biomass has modest degradation over time, an analysis of our biomass on hand resulted in taking a noncash inventory provision of $21.5 million in Q4 for a total of $23.4 million for the year. Inventory provisions are expensed to cost of goods sold, which reduced our reported gross profit and margin in the fourth quarter and for the year overall.

However, this is a noncash item. Secondly, we recorded a negative change related to the fair value of the SB USA purchase option in Q4 in the amount of $6.8 million for a total change of negative $10.7 million for the year. This increases our net loss for the period, but is also a noncash item. The reduction primarily reflects or reduced near-term valuation of the business due to slower-than-anticipated progress on federal legalization for cannabis. Both the fair value change and inventory provisions, again, are noncash items that do not affect our cash position. Moving to the MLB partnership. In Q4 2022, in connection with the promotional rights agreement, the company paid $500,000 as well as recognized $2 million in expense. As we have discussed previously, this is more than a rights deal.

It is a strategic deal where MLB not has a revenue share on the NSF Certified for Sport product, however, they are also a substantial shareholder of the company. Regarding the balance sheet. This transaction resulted in a license and media assets of approximately $30 million and a corresponding payable at the end of 2022. The fourth significant item in the fourth quarter was the $52.7 million net proceeds from a seven-year convertible debenture with BAT. This investment strengthened our balance sheet, significantly improving liquidity. We believe this generated value for our shareholders, providing liquidity for the company at a great price, at a time when capital access is extraordinarily limited. Now turning to revenue. As Jacques discussed earlier, Q4 revenue was $18.9 million, down 23.8% compared to revenue of $24.8 million in the fourth quarter of 2021, with both our B2C and B2B businesses reporting lower net sales.

The comparative result is lapping a stronger Q4 in 2021, following the pass of Bill AR 45 in California, which resulted in materially larger shipments during the period, amplifying the year-over-year comparative decline. Moving to our fourth quarter gross profit. The inventory provision of $21.5 million in the fourth quarter resulted in a gross profit of negative $10.5 million. For better transparency, excluding the inventory provision, gross profit was approximately $11 million or 58.1% of revenue. Looking forward, we expect gross margins to continue being in the mid-50s depending on both product and channel mix within the period. Furthermore, in full year 2022, we reported gross margin of 28.6% due to the previously mentioned inventory provision.

Photo by CRYSTALWEED cannabis on Unsplash

Gross margin before the inventory provision was 58%, which compares to a 2021 gross margin of 61% before provisions. Turning to SG&A. Notably, in 2022, we were able to deliver substantial reductions in SG&A of $27.6 million for the full 12 months. Total SG&A for 2022 was $70.1 million, a year-over-year decrease of 28.2% from $97.6 million in 2021. This excludes a $4.1 million pandemic-related employee retention credit recognized in 2022. With that, cash now — is now receivable on our balance sheet. The material reduction in operating expenses was critical to rightsizing the business and significantly reduces our cash burn to a manageable level going forward. SG&A expenses in the fourth quarter were $21.4 million or 12.2% lower year-over-year.

Combined with our $67 million cash position at the end of the year, this has put the business in a solid financial position moving forward, and we believe this is unique among the bulk of our competitive set. Net loss in the fourth quarter was $35.2 million or $0.23 per share loss with $21.5 million of the loss being inventory provisions, plus $3.5 million loss from fair market value changes. This compares to a fourth quarter net loss of $118.2 million or $0.86 per share loss last year, which included $103.8 million in impairments related to goodwill, inventory provisions and other long-lived assets. For better transparency of operations, excluding depreciation and amortization and other extraordinary and noncash items, Q4 adjusted EBITDA was negative $4.5 million, a year-over-year improvement from negative $8.3 million for Q4 of last year despite lower revenue.

This was primarily a result of SG&A reductions. On a full year basis, adjusted EBITDA improved by $8.7 million versus 2021, resulting in a smaller adjusted EBITDA loss of $11.8 million. As a result of prudent expense management in 2022, net cash used for operations for the full year was $5.3 million in 2022 versus $29.6 million in 2021. The decrease is a result of reduced operating expenses and the collection of $10.8 million in IRS tax refunds, partially offset by lower revenues and cultivation payments. Cash at the end of 2022 was $67 million compared to $19.5 million at the end of 2021. Additionally, our working capital at the close of 2022 stood at $84.1 million. I will now turn the call over to Co-Founder and COO, Jared Stanley.

Jared Stanley: Thank you, Jessica. Prior to going into regulatory, I’d like to give a brief update on Canada. In Q4, we announced a strategic alliance with Tilray, licensing our brands and formulations to make Charlotte’s Web products available in Canada. We are progressing on these plans with tinctures launching in Q2 and capsules, topicals, gummies to follow. All products are subject to royalties payable to Charlotte’s Web on a revenue basis over the four-year term, more to come as we progress. This is just one example of our asset-light international strategy and one path for unlocking value of our IP. To shift to regulatory, I would like to begin by providing some perspective on the recent position made by FDA on January 26.

We support the U.S. Food and Drug Administration’s recent call for Congress to regulate hemp-derived CBD. Over the past four years of investigation, the FDA has not provided a regulatory framework that works under its purview. Statements from the FDA indicate that absent congressional legislation, the situation is unlikely to change. With the FDA’s call to action, we have seen more engagement from Congress in the last two months than ever before. Support and credibility from BAT and MLB drive value that cannot be viewed on our balance sheet. Our leadership in DC starts with our engagement. Congress has requested industry data to understand and address the concerns made by the FDA. Charlotte’s Web and industry peers have compiled and shared with Congress the safety and toxicology data that addresses these concerns.

Shortly afterwards, representatives Morgan Griffith and Angie Craig reintroduced two bipartisan bills, The Hemp-Derived Consumer Protection and Market Stabilization Act of 2023; and just last week, this bill was designated H.R. 1629 to regulate hemp extract products under Dietary Supplement Regulatory framework. And secondly, the CBD Product Safety and Standardization Act of 2023 designated H.R. 1628, which would establish regulations for CBD as a food and beverage additive. We are moving to create a sensible regulatory framework for hemp-derived CBD that ensures compliance for companies. Such regulatory oversight can establish a foundation for product safety, quality and, ultimately, ensure consumer confidence is safe and effective CBD products availability.

We are not only focusing our attention to Washington, D.C., but have also actively been engaged in state-by-state regulation necessary to address Delta THC. Our home state Colorado was a first mover to address the issue of Delta. In late 2022, we sat on the Colorado task force established to make a recommendation to the general assembly by January 1 of this year. Our voice was strong as we led a favorable outcome for the Colorado hemp industry as the current draft of the bill addresses intoxicating cannabinoids, but preserves consumers access to highly therapeutic full-spectrum CBD products. Additionally, the Colorado bill will establish transparency to consumers by creating THC labeling requirements. In order to maintain consistency in Charlotte’s Web products and get ahead of state labeling requirements, we have to set a shelf life on our biomass to ensure future specification set will comply with pending state labeling regulations.

The substantial biomass that was produced in 2019 in preparation for an anticipated FDA regulated category that hasn’t yet come, created a supply of aging biomass inventory that will not meet future specifications due to THC degradation. These labeling requirements are the triggering event behind our decision to write down a significant portion of our biomass. However, the company holds enough biomass and extract in specification to satisfy future sales. Colorado is a leader in both cannabis and hemp for the nation, and we are hopeful our home state will become a model state for future rules and regulations. We also recently announced the appointment of our new Chief Scientific Officer, Marcel Bonn-Miller. Marcel comes to us with over two decades of excellence in cannabinoid research.

He is leading product development clinical research, scientific regulatory support and more specifically, interfacing with the FDA science teams to support a regulatory pathway for hemp CBD extracts. His experience is key to supporting our regulatory and scientific goals as we innovate. And as we navigate and lead the regulatory landscape, we are excited to bring the market an innovation pipeline to accelerate growth in the back half of 2023 and 2024. The NSF Certified for Sport Daily Edge tincture was the tip of the iceberg. We are strategically innovating with the consumer at the heart of every decision. The MLB partnership has played a pivotal role in this. We presented at MLB winter meetings in December and connected with more than 20 teams over spring training to educate trainers and decision-makers on broad-spectrum CBD.

If our NSF Certified products can support premier athletes to faster recovery, mental clarity, energy and sleep, imagine what they can do for the everyday consumer. Our MLB partnership and innovation pipeline are core to our primary strategy, grow the business. Our engagement with Congress to land a regulatory landscape for CBD is driving the second leg of our strategy, when in D.C. But I’d like to provide additional color to the third leg of our strategy, botanical wellness. On the Q2 2022 earnings call, we discussed that we were exploring an investigational new drug pathway through the FDA. On our Q3 call, we further discussed the reasons why and how we could do this on a capital-free basis through potential partnering. Charlotte’s Web’s unique advantage lies in its intellectual property, including 7 hemp patents, safety and toxicology studies, GMP quality control systems and a state-of-the-art manufacturing and distribution facility.

Our IP can be licensed into a biotech partnership leveraging a clinical science and regulatory team to seek an IND and navigate clinical trials to, ultimately, create a botanical drug. The CBD market is estimated at $5 billion today with approximately $1 billion from Epidiolex, the only FDA-approved CBD drug to date. By partnering on an IND path, we provide risk-mitigated upside to our shareholders by unlocking IP value created since the inception of the company and leveraging our core strengths. We are progressing with speed on this strategy, and we look forward to updating deeper as this leg unfolds. I’ll now hand the call back to Jacques.

Jacques Tortoroli : Thanks, Jared. From what we learned in 2022, we’re going to be cautious about our outlook for 2023, considering we could still be another year of federal ambiguity and state movements, but we’ll be ready when regulations do land. To that end, we continue to focus on what we can control by executing on our three-pillar strategy of returning to growth, winning in D.C., and unlocking the value of IP in botanical wellness. We significantly reset the company in 2022, rightsizing the cost base by lowering personnel costs, product offerings and operating complexity, and we intend to maintain these efficiency improvements. We added a new leadership team across key business functions in sales, e-commerce, operations, sports marketing, quality and science, manufacturing, and of course, Jessica.

We entered new distributor partnerships, including the first-ever employee — employer CBD wellness program, new customers in new industry verticals, such as Wynn Hotels in Las Vegas. These partnerships will become more meaningful contributors to our top line over time. In October, we struck a groundbreaking strategic partnership with MLB via the only NSF Certified broad-spectrum product for sports called Daily Edge. MLB also became a meaningful shareholder in our company, and the partnership unlocks enormous relevant reach and audience for us, while supporting the lead’s commitment to mental and overall wellness for its players and about 180 million fans. We’re excited for the new season getting underway and executing across its Jewel Events as well.

As Jared mentioned in November, we partnered with Tilray for the manufacturing and distribution of Charlotte’s Web products in Canada. This is the first of its kind agreement for Charlotte’s Web to license our brands, intellectual property and formulations to a trusted international partner. It’s a good example of our asset-light model for international market penetration. In November, we took liquidity concerns off the tables with the strategic investment from BAT in the form of an attractively priced convertible debt instrument. The $67 million in cash on the balance sheet at December, we have the liquidity to choicefully invest in growth initiatives consistent with our strategy. Capital access has become very limited within the category, and we see this as only reinforcing our right to win and an enormous competitive advantage.

Finally, we took a hard look at our existing consumer brands, products, formats and our innovation pipeline. We did consumer research and drove deep into consumer segmentations. We looked at the competitive land pricing scapes. We are prepared to leverage our unique partnership with MLB and our NFS certification with a pipeline of innovation over the coming years. All this sets up 2023. We have the right to win and build our leadership positions. Our 2022 partnerships with new distributors, MLB and BAT clearly evidence that. While we can’t control the regulatory landscape, we have a voice that is respected and we’re engaged. Our brands, people, IT, science and full and broad spectrum formulations, unique seed-to-shelf supply chain and the state-of-the-art facility, our quality, all put us on top of the category today and our strategy that the liquidity to execute it clearly sets the path for the long game.

When you’re breaking ground on a new and entirely new health and wellness category, it takes a combination of persistence, strategic thinking and unwavering tenacity to stay on the top despite these obstacles. We’re committed to seeing this category through regulatory hurdles, ensuring consumer access to natural CBD and expanding our business to serve natural wellness seekers worldwide. That’s our legacy. That’s 2023. That’s the path forward we walk by putting the consumer at the heart of everything we do and don’t. With that, let’s open the floor to questions.

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Q&A Session

Operator: Your first question comes from Derek Dley from Canaccord Genuity.

Derek Dley : Just a few questions here. So one on — in terms of the rightsizing of the cost structure, mainly as it relates to the OpEx or the SG&A, that $70 million rate that you had in 2022, is that an effective run rate that we should use going forward? Or is there more optimization to be at in ’23?

Jessica Saxton : No. That is our expected run rate going into 2023.

Derek Dley : Okay. And then given that and given the mid-50s gross margin guidance, what would be the revenue base that you would need to become EBITDA neutral or cash flow neutral?

Jacques Tortoroli : Derek, it’s Jacques. Thanks for the question. Predicting revenue is, as we’ve seen last year and this year, is not something we’re going to try to do. What we are going to do, though, is continue our commitment to ensure that the savings that we made last year are maintained, while at the same time, within that existing run rate that Jessica mentioned, choicefully invest behind the right initiatives that fit our strategy across innovation, across the right way to spend paid media to support MLB activations and return to the top of the funnel growth in our e-commerce business. So we’re focused on minimizing the amount of cash burn but we’re focused on choicefully investing within that SG&A run rate to really amplify the ability to get the top line to be in a better place than it was last year.

Derek Dley : Okay. Given the — actually, just in terms of the mix that you guys had, DTC versus business-to-business, is that, again, a mix we should use going forward, call it sort 2/3 direct-to-consumer?

Jacques Tortoroli : Yes, Derek, it’s Jacques again. I think that’s fair. Look, I mean, look at the size of e-commerce in the category. It’s twice the size of the retail categories we play in. I think we have opportunity, obviously, given our position, but relatively small percentage of the market and still being the leader in both of those channels within the market. I would expect that the ratio of e-comm and B2B stay relatively constant in the short term.

Derek Dley : Okay. And just remind me, e-com is higher margin, right?

Jacques Tortoroli : Yes. And I was going to say that’s also an element to the mix of margin and the guidance that Jessica mentioned. So clearly, the margin in e-commerce is better than the margin in retail.

Derek Dley : Okay, and then last one for me. Just in terms of — I know you’ve spoken to it in the past just in terms of competition, given the high fragmentation of really small brands, which presumably, given your comment on access to capital are starting to go away, but have you seen any stabilization in pricing? Is it mostly on the value end? Is it across the entire channel? How are you viewing that?

Jacques Tortoroli : Yes. Look, I’m not sure I’d say it’s stabilization of pricing. But I think what we continue to see is the shift to value pricing, which, by that, I mean the depth and frequency of our — the industry’s promotional pricing at both channels, which continues. I mean it’s interesting to look at the MSRP versus the average retail price, right? And the average retail price in natural channel, for example, was down slightly. While in the food, drug and mass channel, was down 11% in 2022. I mean the reality is because the consumer pull isn’t there for a lot of these other brands and they don’t have the brand equity that Charlotte’s Web has, the only lever they have is to reduce pricing and try to move product off shelf.