Verano Holdings Corp. (PNK:VRNOF) Q3 2023 Earnings Call Transcript

Verano Holdings Corp. (PNK:VRNOF) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Thanks for standing by, and welcome to the Verano Holdings Corp. Third Quarter 2023 Earnings Conference Call. I would now like to welcome Julianna Paterra, VP of Investor Relations to begin the call. Julianna, over to you.

Julianna Paterra: Thank you, and good morning, everyone. Welcome to Verano’s Third Quarter 2023 Earnings Conference Call. I am joined today by George Archos, Chief Executive Officer and Founder; Brett Summerer, Chief Financial Officer; Darren Weiss, President; 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 for the quarter ended September 30, 2023. In addition, throughout today’s discussion, we will refer to non-GAAP financial measures that do not have any standardized meaning prescribed by GAAP. 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 their respective most directly comparable GAAP financial measures.

Lastly, all currency is in U.S. dollars, unless otherwise noted. I’ll now pass it to George.

George Archos: Thank you all for joining us today. The third quarter was an exciting and productive time for Verano, highlighted by positive results and strategic enhancements across our business and we are pleased to share details on our progress today. I will begin with a brief recap of our strong third quarter results before our President, Darren Weiss, provides commentary on legal and legislative developments. Our Chief Financial Officer, Brett Summerer, will then provide a deep dive into our financials before our Chief Investment Officer, Aaron Miles, covers capital market updates. I will then provide some closing thoughts on our outlook before taking questions. I am so appreciative of our team as they continue to set the industry standard on multiple fronts over the course of the quarter.

Verano is not only thriving in the current environment, but we are executing on our plan to establish and run the business for long-term growth, enabling the company to navigate changing market landscape in an otherwise challenging macro environment. We also recently took a major positive step forward by uplifting our publicly traded shares to CBOE Canada which we believe strengthens our ability to move quickly to a U.S. stock exchange if and when we receive approval to do so, which should open the doors to a new and larger investor base. We believe that the swift execution and elevation of our capital market strategy best positions Verano for access to more robust equity markets, especially as the U.S. market dynamics continue to evolve. In preparation for possible new investment dollars and consistent with our desire to stand out as a market leader, we are proactively enhancing the transparency of our financial disclosures.

This quarter, we have disclosed additional state-level data, which we believe will be meaningful to investors, especially given the opacity of the industry. Looking ahead, we plan to continue to lead the way in enhanced disclosure and will work to evolve and supplement our disclosures, particularly as we believe more robust reporting can help break down investment barriers for some institutional investors. Moving to third quarter results. We achieved $240 million in revenue, representing 5% year-over-year growth, led by increases in Connecticut wholesale sales and strong results from Maryland’s adult use launch. Most significantly, we generated a record $37 million of net cash provided by operating activities in the quarter, bringing our year-to-date total to $77 million.

And with our CapEx guidance for the year, this implies delivering full year net cash provided by operating activities of $102 million to $113 million. Regarding free cash flow, we also generated a $27 million in the quarter, bringing our year-to-date total to $51 million. Although many of our competitors only report on net cash provided by operating activities, we believe free cash flow provides a useful data point, representing cash available to the business, even after funding growth initiatives. On our first earnings call this year, we stated that our top priorities were strengthening our balance sheet and generating free cash flow. I believe we have set the standard for the industry with our progress year-to-date, and we will continue to prioritize these items throughout the fourth quarter.

We increased our cash balance to $130 million, up from $103 million at the end of the prior quarter, consistent with our previously stated goal to build our cash balance. We believe available cash provides us more financial flexibility to take advantage of opportunities and manage our financial position, including debt reduction. As a reminder, we have a favorable prepayment fee of $1 million on the first $100 million of debt prepaid under our credit facility. And in October 2024, our prepayment fee and the debt balance is reduced to a mid-single-digit percentage further decreasing in October 2025. Given our progress year-to-date, I am pleased to announce that we are raising and tightening our full year 2023 free cash flow guidance to $72 million to $76 million, up from $65 million to $75 million.

Note, this guidance includes an expected tax payment of around $50 million in the fourth quarter and is based on assumptions of operating in today’s environment, making no assumptions of legislative moves or opportunities that may materialize in the space. As things progress, we may decide to utilize extra cash for strategic or growth opportunities. Moving to broader demand dynamics, we continue to see sustained demand across our portfolio. Consumers are consistently buying more product than ever in terms of units and in turn, we are selling more product than ever, even in markets where we had hit retail caps and are subject to strict advertising constraints. While growing demand is often overshadowed by a focus on revenue trends, we believe growing demand is a positive structural indicator.

In the third quarter, we increased units sold across retail and net wholesale channels by 19% year-over-year. Across our net wholesale channel, we increased units sold 10% year-over-year. And in our retail channel, we increased units sold by 23% year-over-year, and we see this trend in both nascent and mature markets. For example, in our more mature adult-use markets of Arizona, Illinois, Nevada and Michigan, total retail and net wholesale volume increased 18% versus the prior year, led by particular strength in Arizona retail. In Connecticut, one of our newer adult use markets, demand measured by total retail and net wholesale volume has grown steadily, up 4% sequentially. We’re even experiencing demand increases in more mature medical markets with total volume across Florida, Pennsylvania, Ohio and West Virginia up 10% for the third quarter year-over-year.

We believe that strong and growing consumer demand is a clear tailwind for our business despite downward pressure on pricing in certain markets. And as prices and supply continues to stabilize, we believe the often overlooked demand story provides a recipe for organic growth. I would now like to take a few minutes to highlight some key developments in select markets before talking about brands. I’ll begin with our 2 newest adult-use markets, Connecticut and Maryland. Connecticut continues to display strength with both retail and net wholesale revenue increasing each quarter this year to date. As of today, we have 4 open dispensaries, including 2 social equity joint ventures and anticipate that our remaining 4 additional joint venture dispensaries will open over the course of the next year.

Maryland has also performed well in its first quarter of adult-use sales with our branded market share growing steadily this year, now up to over 7%, which is within the top 5 for the state according to BDSA data. And in Illinois, we are beginning to see some pricing pressure reemerge in the retail market from new social equity dispensaries. While we believe that ultimately, these new dispensary openings will be a net positive for us, given they offer further wholesale opportunities, we see this as a headwind. Nonetheless, we continue to prioritize both our margin and maintaining our price points. In New Jersey, Verano remained the #1 brand for the quarter, and Savvy, which was only recently released this past June is already the #5 brand in the state according to BDSA.

With competition increasing in New Jersey as additional retailers enter the market, we anticipate that our net retail sales will decrease mid- to high single digits sequentially. However, we still expect opportunities for modest sequential growth in our New Jersey net wholesale revenue over the midterm, especially given our top brand positioning in the state. Turning to our branded products. I would like to take a moment to outline our progress in developing and deploying a growing portfolio of industry-leading brands. As many of you know, in our early days, we focused on premium positioning across our product lineup, which is arguably the toughest niche of brand segmentation. However, over the past 12 months, we have leveraged our deep data insights to develop and launch products to meet new consumer wants and needs, accelerating our brand releases.

We have launched over 100 products over the past 12 months, which contributed 43% of our company revenue in the third quarter, up from 21% in the third quarter of 2022. We view this as a testament to the new consumer segments we’re reaching with a much more extensive suite of brands and products. From brand extensions to our Savvy lineup, including rough cut flower and single serve edibles to solventless extracts and infused pre-rolls, we have turbocharged our innovation and creative engines, striving to deliver consistent, high-quality and wallet-friendly products with the target of maintaining strong margins and generating free cash. And as a data-driven company, we are constantly evaluating new information and persistently pursuing innovation, so I expect you’ll continue to see exciting innovative launches from us.

And now I’ll turn it to Darren to provide some commentary regarding legal and legislative developments.

Darren Weiss: Thank you, George. Beginning with Ohio, we are thrilled to see initial results indicating that Ohio’s constituents voted in favor of adult use this week. Under the proposed program, our existing licenses would allow us to open an additional dispensary, giving us 6 retail locations in the state in addition to our 22,000 square foot cultivation facility. However, while we very much look forward to the opportunity to further serve the Buckeye State, there is a chance that this program can be amended or even repealed by the state government as a result of Ohio’s unique ballot initiative process. Assuming the program is fully implemented, Ohio is estimated to generate a total of over $200 million in annual tax revenue from cannabis sales in 2024, according to the OSU Drug Enforcement and Policy Center versus only $118 million from alcohol sales in 2022.

Although we are hopeful the state will be able to realize many benefits of implementing a safe and regulated adult-use program, we are not celebrating just yet. We call on the Ohio legislature and the governor’s office to support the will of the state voters to implement an adult-use program quickly and provide its adult citizens with access to cannabis. With respect to Florida, we eagerly awaited decision as to whether adult use will appear on the State 2024 ballot. As many of you know, oral arguments are scheduled for this afternoon on the measure. Given the governor’s previous position towards adult use cannabis and Attorney General Moody’s challenge, we see Florida adult use as an uphill climb, but we’re hopeful that the Supreme Court will do the right thing and leave it up to the voters to decide.

We look forward to hearing the outcome from the oral arguments later today, and our Florida team remains ready and prepared regardless of the result. In the meantime, the Florida medical market remains a strong contributor to Verano’s success with 72 locations today and what we estimate is 12% of total market share by revenue. Moving on to federal progress. We are, of course, encouraged by the news of HHS’ recommendation in August to reschedule cannabis from Schedule I to Schedule III. Although this schedule change doesn’t give us everything we want or everything that our patients and customers deserve, merely the recognition from the nation’s leading health department that cannabis provides safe and meaningful medical benefits is a massive accomplishment.

Along with other industry participants, we are eagerly awaiting the DEA’s response to the recommendation. We anticipate the DEA accepting the recommendation and promulgating rules to that effect. Although there is no guarantee on outcome, we are also bullish on there being additional protections for state legal, medical and adult-use markets through a forthcoming DOJ issued memorandum. Between rescheduling and a new memo from DOJ, we can realistically see the elimination of 280E, which would, of course, be incredibly meaningful to the industry. We hope to hear the DEA’s response by early 2024. But as we’ve always said, we don’t operate the business assuming policy or legislative changes. As a result, these developments, while welcome, don’t and won’t change how we continue to run our business.

We will maintain our conservative approach to operating. We will continue to prioritize cash generation, and we look forward to what we believe will be good news for our industry next year. Lastly, I’d like to address the groundbreaking lawsuit that was filed in October against the U.S. Attorney General in which Verona is a plaintiff. This case has been developed over quite some time by a coalition of operators and investors with Verona having one of the leading roles in the initiative. As a member of the steering committee for this litigation, I am honored to be working with a phenomenal cohort of industry participants, and we are grateful for the support of both small businesses and operators as well as several large MSOs. Based on how cannabis is regulated at the state level, changes in commerce plus juror’s prudence and the current makeup of the Supreme Court, we filed this case asking the U.S. Federal Court to declare that the Controlled Substances Act simply does not apply to state legal cannabis businesses operating in compliance with state regulations.

We believe the federal government has no basis for enforcing the Controlled Substances Act against intrastate state-regulated cannabis operators and seek to confirm the rights of states to regulate cannabis within their borders. We collectively hold a strong conviction in our cause and more importantly, believe this lawsuit can and will help small struggling businesses that are desperately in need of federal change. As with all legal proceedings, we know this will be a process. And during the pendency of the case, other developments in D.C. could solve a number of these issues. We will update our investors if we have any further material developments on this important matter. Now I will pass to Brett to walk through the financials in more detail.

Brett Summerer: I am pleased to share details on what was another strong quarter for Verano. Third quarter 2023 revenue was $240 million, up 5% compared to the third quarter last year led by wholesale strength in Connecticut and Maryland. Sequentially, revenue was up 3%, driven by strength in Maryland as its adult use market launched on July 1. On a gross revenue basis, excluding intersegment elimination, 67% was derived from the retail side of the business and 33% from the wholesale business. Gross profit for the quarter was $133 million or 55% of revenue, up from $123 million or 54% in the prior year period, driven by increased vertical mix, top line growth and new product launches, slightly offset by pricing pressure. Our vertical mix or Verano sell-through remains high at 46% for the quarter, excluding Florida, Arkansas and Michigan as we do not wholesale in those markets.

We anticipate our vertical mix remaining in the high to mid-40s for the foreseeable future. SG&A expenses were $86 million for the quarter or 36% of revenue, about flat with $86 million or 38% of revenue for the prior year period. We had a net loss for the quarter of $18 million and an adjusted EBITDA of $89 million or 37% of revenue. We had a positive impact of about $6 million or 3% from inventory this quarter as we build levels in Arizona and New Jersey, ahead of what is usually a high-volume fourth quarter. We do not expect margins this high going forward, but as always, anticipate levels above the industry average. Turning to the balance sheet and cash flows. We ended the quarter with $130 million in cash and cash equivalents, growing our balance $27 million from the second quarter’s balance.

We will continue to evaluate the best use of our excess cash in the near term with plans to deploy it in a way that maximizes shareholder returns. Our acquisition consideration payable is nearly eliminated with only $2 million remaining as of the end of the third quarter. In addition, we continue to effectively manage our income tax payable balance and although it increased sequentially to $250 million, this is merely a function of our estimated tax accrual for 2023, outpacing that of older tax accruals given our growing gross profit driven by stronger performance of our business. As a reminder, we guided our first quarter 2023 earnings call that we anticipate maintaining an income tax payable balance around $250 million, assuming fluctuations of about 5%.

That said, we have made $115 million of tax payments year-to-date, which includes $27 million in the third quarter. Looking ahead, we anticipate maintaining a balance at year-end around our stated guidance level. CapEx spend for the third quarter was $10 million or $27 million year-to-date. In line our free cash flow guidance, we anticipate only spending between $30 million and $37 million in CapEx for the year outside of any adult-use preparation or M&A spending that may come up this year. Net cash provided by operating activities for the quarter was $37 million, contributing to the $27 million of free cash flow generated in the quarter, bringing our year-to-date free cash flow total to $51 million. As George mentioned earlier, we are raising and tightening our full year free cash flow guidance to $72 million to $76 million up from $65 million to $75 million.

Of note, this range accounts for the tax payments previously discussed. However, if we decide to get more aggressive in bringing down our tax balance, that is essentially an increased dollar for dollar impact to free cash flow. We are meeting or exceeding our internal 2023 financial goals year-to-date, and our momentum keeps growing. We have invested a lot of resources to build our internal capabilities, and we are benefiting from those efforts as we have built a solid balance sheet and continue to build our reporting strength ahead of a potential U.S. market inclusion. It’s important to evolve the transparency and disclosure of our information, and I look forward to providing updates on our full 2023 performance next year. Now I’ll pass over to Aaron, who will provide more detail on our exciting move to CBOE Canada.

Aaron Miles: Thanks, Brett. As George mentioned at the beginning of our call today, we have recently made the move to CBOE Canada from the Canadian Securities Exchange, which I would like to highlight in more detail. CBOE Canada sits within CBOE’s global platform, a globally recognized exchange encompassing 26 markets, allowing CBOE Canada to benefit from CBOE’s global scale, distribution and capabilities. Although it’s more commonly known for its leading specialization in futures and options, CBOE has built out a corporate listings business in recent years, most notably through the acquisition of the NEO Exchange and the launch of CBOE U.S., a bonafide U.S. exchange established to compete with the NYSE and NASDAQ. Of total equity volume traded within the U.S., NYSE and NASDAQ hold the top 2 spots with mid- to high teens market share.

However, CBOE U.S. is right behind them averaging around low to mid-teens market share volume traded. It also holds a dominant market share of about 1/4 of volume traded in Europe. Overall, this was a very deliberate and strategic move for us. And while we expedited our decision in listings application on the heels of the HHS announcement, we have persistently evaluated and reevaluated our capital market strategy since going public in Canada in 2021. First and foremost, this move gives us a senior exchange status and further aligns us closely with your listing requirements of U.S. exchanges. Listing on a Tier 1 exchange is a commitment and a mandate to adhere to higher standards as an organization, which aligns us with our commitment to enhance transparency of information George highlighted earlier.

Given we are listed on a CBOE network Exchange, which also has a U.S. listings business, we believe we are positioned for a smoother transition into the U.S. if and when we get approval to do so. In addition, unlike alternative options, this move did not require any costly or cumbersome corporate restructuring and allows us to continue to operate our business as is, including using our stock as currency for acquisitions should we desire to do so. CBOE Canada also implements a designated market maker model, which we believe is an opportunity to strengthen liquidity and enhance trading efficiencies while working towards curbing predatory trading. It also offers broader institutional investor access in addition to eligibility into the world’s largest index benchmarks from MSCI and FTSE Russell.

We are excited about this move and continuing to improve upon our capital market strategy. With that, I’ll pass it back to George for final comments.

George Archos: Thank you, Aaron. We communicated on earnings calls earlier in the year that we anticipated an active year for M&A as smaller operators feel price-driven pressures, and obviously, that has not yet materialized. I want to reiterate, however, that we remain interested in M&A, and we’ll continue to evaluate accretive opportunities across the cannabis ecosystem to grow our business and improve verticality. Moving to our guidance for the fourth quarter, we anticipate a sequential low to mid-single-digit decline on top line revenue, given the typical increase in promotional activity in the fourth quarter and as our New Jersey retail environment normalizes alongside new store openings. Despite this anticipated short-term dip in the top line, we still project growth drivers for 2024, which include the 4 social equity joint ventures yet to open across Connecticut and the opportunity to open 7 social equity joint ventures in New Jersey.

And even as competitive pressures persist, we remain committed to our strategy of avoiding irrational pricing as we are focused on maintaining our high-quality brand identities. We look forward to providing further updates on our fourth quarter and full year call, especially our progress on our free cash flow guidance of $72 million to $76 million for 2023, which we believe is the largest reported free cash flow guidance in the industry to date. In closing, we will continue to strategically disrupt, innovate and differentiate Verano at every level of our business. I am proud of what we’ve accomplished, and I look forward to our future. Operator, can you please open up the line for questions.

Operator: [Operator Instructions]. Our first question comes from the line of Aaron Grey with Alliance Global Partners.

Aaron Grey: Congrats on the quarter here. So first question for me is on the gross margin. So we saw some notable improvement there quarter-over-quarter. In the PR and on the call, you guys spoke to some of the vertical sell-through increasing quarter-over-quarter and kind of helping that there. I know retail mix of sales was down quarter-over-quarter. So on a quarter-over-quarter basis, it implies some of the vertical mix might not have been as much of a benefit. So just curious to other factors that might have driven that improvement, maybe less of an impact from some of the inventory rightsizing that we’ve seen weighing on margins in the first half of the year. So any commentary on your comfortability of maintaining gross margin at this level?

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Q&A Session

Brett, I believe you said you don’t expect them to remain this high going forward. So any expectation in terms of other factors that impacted the improvement quarter-over-quarter? And how do you think about gross margins going forward, would be helpful.

Brett Summerer: Sure, thanks for the question. So gross margin in general continues to track to the level that we’ve guided in the past on an operating basis, so excluding inventory movements and stock-based compensation. So we’re still in that kind of range that we talked about before. What happened this quarter is we delivered that, although it was kind of towards the upper end of our range that we typically have talked about. In addition to that, we also had growth in inventory in New Jersey in preparation for some of these social equity joint ventures and other — these countries opening up. We’ve added significant inventory there, about 5 million grams. And then in Arizona, we added about 1 million grams, which is due to additional support for the market.

So we actually had underserved Arizona and we did some adjustment to our inventory there to make sure we don’t continue to do that. So all in, about $6 million worth of inventory adjustments, about 3% of our gross margin, a little bit less than 3%, call it, 2.5% in our results is driven entirely by that inventory movement and the rest is again pretty flat to the range that we’ve talked about in the past.

Aaron Grey: Okay. Great. That’s really helpful color there. And then second for me, I know there’s still some uncertainty and a bit early because as we think about potentially the DEA coming out, a lot of folks talking about the 280E cash flow implications. Just as you guys have been thinking about allocation with the additional capital and cash flow, that could come in from the 280E change. How do you think about the allocation between maybe paying down debt, tax payables or utilizing that additional cash flow for growth via CapEx or M&A. So just in terms of where you guys mindset is now in terms of how you guys might utilize that extra cash flow that could come in, in the event of 280E change?

Brett Summerer: Sure. No, I will say right now, we’re really blessed for choice, and we have a significant amount of cash on our balance sheet that we’re thinking through how we want to apply that. But we’re looking at the highest returns and what the best — what’s best for investors. Everything is on the table. M&A opportunities are out there. We have some capital expansion opportunities, especially with the news of Ohio. Obviously, we need to take that into account. We also have optionality to pay down taxes or the flexibility of our debt to kind of take out 1/3 of that debt with a low — almost 1/3 of that debt with a low upfront payment. So I’d say all options are on the table. We do have a significant amount of cash on the balance sheet. So we’re going to be able to have a great decision ahead of us here in the coming months. And this will just add to that pile.

Operator: Our next question comes from the line of Matt McGinley with Needham.

Matthew McGinley: So you’ve been building momentum in the wholesale business this year with pretty nice sequential increases every quarter as part of that low to mid-single-digit revenue decline that you had noted that you expect in the fourth quarter. Do you expect that to be more of a retail decline? Or should we assume some wholesale pressure there as well?

Brett Summerer: Yes. Thanks for the question. So overall, we do have a very high — or we tend to see very high discounting in Q4. And as a result of that, we also see a significant amount of sales in preparation for those sales in Q3. So you just don’t typically see as much of a lift on the wholesale side just because people are starting to stock up here towards the end of Q3 in preparation for the [Technical Difficulty] so right now, it’s always hard to judge that because of seasonality and discounting and whatnot, but that’s one of the bigger drivers there.

Darren Weiss: Yes, Matt, this is Darren. Thanks for the question. I would just add, one of the things that we talked about and we’re as we’re looking at the future is just what’s going on in New Jersey, the impact of the additional stores. Obviously, it gives us opportunity for wholesale to get on more shelves and to maintain our very strong market share position. But that’s one area where we expect and have expected really since the start of the program to see eventual declines as we have more doors across the state.

Matthew McGinley: Got it. And on the — what do you think the opportunity is for new unit growth next year outside of the JV units that you noted you would be able to put up in Florida? And I guess specifically — or I’m sorry, in Connecticut rather to the JV, but in Florida, it doesn’t make sense to continue to put up new units there under the medical program if they really aren’t moving the needle on overall revenues in the state?

George Archos: Matt, this is George. Thanks for the question. So we do still see further opportunity in Florida. We’re being very selective on the markets that we’re choosing. But the new stores that we’re opening, although they’re not ramping as greatly as they were before, it is still doing very well for us. We’re just being very selective in the markets. There’s still a number of cities that we’re not in. So when and if it makes sense, we transact as we’ve shown in the past. So I think you will see some additional units from us in Florida next year. But obviously, we’re looking forward to this adult use transition if and when it happens. So that will be a big driver as well. But the medical market is still doing very well for us.

Matthew McGinley: Okay. And I just want to say thank you very much for the increased disclosure you provided this morning in your press release. It really does make it much easier to understand the business and those disclosures are really best in class. So thanks for providing that additional information on the state level trends.

George Archos: Thanks, Matt. Looking forward to giving you guys some more.

Operator: Our next question comes from the line of Scott Fortune with ROTH.

Scott Fortune: I’d like to echo, thanks for introducing that state level revenue functions there and transparency, that’s helpful. But with that said, can you provide a little more color on kind of looking out to ’24, and we have — we see the Ohio potentially coming onboard here, the new states of Connecticut, Maryland, New Jersey continuing to fully ramp, as you’ve talked about. But more color on the large markets of Illinois, Massachusetts, Pennsylvania, even Florida that you’re in. And then what will kind of — you mentioned a little bit of the store side of things, but kind of your CapEx needs looking into ’24 to build out here, that would be helpful to provide a little more color looking out.