SHWZ - Medicine Man Technologies Inc. (SHWZ) Q3 2023 Earnings Call Transcript
2023-11-14 19:28:08 ET
Medicine Man Technologies, Inc. (SHWZ)
Q3 2023 Earnings Conference Call
November 14, 2023, 5:00 pm ET
Company Participants
Sean Mansouri - Elevate IR
Nirup Krishnamurthy - CEO
Forrest Hoffmaster - CFO
Justin Dye - Chairman
Conference Call Participants
Presentation
Operator
My name is Lester, and I will be your conference operator today. At this time, I would like to welcome everyone to Schwazze Third Quarter 2023 Conference Call. All lines have been placed on mute to prevent any background noise. Following their prepared remarks, management will take questions submitted via the web link found in Schwazze's Investor Relations website and in the earnings press release.
I would now like to hand over the conference to company's External Head of Investor Relations, Sean Mansouri of Elevate IR. Sir, please go ahead.
Sean Mansouri
Thank you. Good afternoon, and welcome to Schwazze's third quarter 2023 earnings conference call. Joining me on the call are Nirup Krishnamurthy, Schwazze's Chief Executive Officer; Forrest Hoffmaster, Chief Financial Officer; and Justin Dye, Chairman of the Board. The company will begin with prepared remarks and then we will open the call for Q&A.
I'd like to remind you that management's prepared remarks and answers to your submitted questions may contain forward-looking statements, which are subject to risks and uncertainties. Examples of forward-looking statements include, among others, statements regarding federal and state legislation and regulation, Schwazze's future results of operations and financial position and Schwazze's business strategy and plans and objectives for future operations.
Such forward-looking statements may be preceded by the words plan, will, may, continue, anticipate, become, build, develop, expect, believe, poised, project, approximate, could, potential or similar expressions as they relate to Schwazze. Investors are cautioned that all forward-looking statements involve risks and uncertainties that may cause actual events, results, performance or achievements to differ from those anticipated by Schwazze at this time.
Additional information concerning factors that could cause events, results, performance or achievements to differ materially is available in Schwazze's earnings release made available before this call and available on Schwazze's Investor Relations website and in Schwazze's Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 29, 2023.
In addition, other information is more fully described in Schwazze's public filings with the U.S. Securities and Exchange Commission, which can be reviewed at sec.gov or on www.sedar.com or on the company's Investor Relations website.
Also, Schwazze may discuss non-GAAP financial measures during today's call. A reconciliation of the differences between the non-GAAP financial measures discussed during the call and with the most directly comparable GAAP measure can be found in Schwazze's earnings press release made available before this call and available on Schwazze's Investor Relations website.
I'd now like to turn the call over to the company's CEO, Nirup Krishnamurthy, for opening remarks. Nirup?
Nirup Krishnamurthy
Thank you, Sean. Good afternoon, everyone, and thank you for joining us to discuss our financial and operating results for the third quarter of 2023.
I'd like to start by quickly touching on the broader macro environment. Inflationary and pricing pressure has continued to impact consumer wallets across most industries in the third quarter. Our industry is not immune to these pressures either. Nevertheless, we continue to focus on our sales, our customers and cash flow generations in our operations. We have always prided ourselves in our ability to run a lean operation, while being good stewards of capital, which has materialized in our strong adjusted EBITDA margins and consistent cash flow generation, even in challenging market conditions.
While the industry awaits potential legislative change, we will continue to implement the Schwazze operating playbook to profitably scale our regional footprint regardless of outcomes in D.C.
Now let's dive into our results. In Q3, we continue to increase our retail footprint in both Colorado and New Mexico, while further integrating our recently acquired assets in both states. In New Mexico, we worked diligently during the quarter to integrate Everest Apothecary, which we acquired in June. As of today, we have fully onboarded the retail, cultivation and manufacturing assets onto our financial and operating systems. While it is still early in the integration cycle, we have begun to recognize synergies through consolidating resources and optimizing production facilities amongst other initiatives.
In Colorado, we have increased efforts to expand our reach to medical patients through the Standing Akimbo banner with new presence in Colorado Springs and Fort Collins. We also opened a new Star Buds store in Lakewood in August and are seeing promising early results. Alongside new store openings, we are currently remodeling and/or relocating certain stores to further enhance customer experience. Although, we have made significant progress on integrating our newly acquired assets, we were not immune to the broader macro pressures in either Colorado or New Mexico.
In Colorado, which has almost 680 active adult use dispensaries across the state, pricing and licenses in new jurisdictions have continued to put pressure on our top-line. Year-to-date, cannabis sales in Colorado are down 13% year-over-year and down 31% on a two-year stack. We, however, continue to focus on our operating playbook and on customer acquisition, while enhancing our in-store experience and optimizing our operating costs.
Wholesale pricing has begun to more broadly stabilize throughout the state, even returning to modest sequential growth in quarter three. Although not reflected yet in retail pricing, flower average market rate increased 7% from $703 a pound in quarter two to $750 a pound in quarter three.
In New Mexico, cannabis operators are navigating pricing pressure as a result of the proliferation of new licenses. Legal cannabis states in the state were up 19% year-over-year in quarter three, while total store count was up 76%, resulting in lower revenue on a per store basis. Approximately 200 retail stores are open year-to-date, bringing the total stores up to more than 650 as of September 30.
To navigate this market dynamics, we are strategically investing in the retail experience and are committed to attracting and retaining our customers and patients in the state. Our strategy is to first, further integrate the Everest assets while refining assortment, in-stock position and standard costs from a combined integrated supply chain. Second, invest in our retail -- leading retail position by bringing new products to our shelves, while sharpening pricing and promotional efforts. Third, support the state as it implements cannabis regulation and enforcement to heighten testing and safety standards. And finally, continue to expand our wholesale business in the state.
While our quarter three results reflect some of these investments and market dynamics, we are well-positioned to leverage our footprint to be the preferred retailer of choice in New Mexico in the future.
Now, let's take a deeper dive into operational updates within each of our markets, starting with Colorado. In late October, we launched the state's first store-within-a-store concept in Fort Collins. This idea was conceived through a survey of Northern Colorado customers, which revealed they wanted to experience characteristics from both Star Buds and Standing Akimbo. The model combines a Star Buds neighborhood dispensary with the Standing Akimbo medical banner, allowing us to serve both medical and adult use consumers under one roof. Although, we just opened, initial customer feedback has been strong and we are excited about progress to-date.
During the quarter, customer loyalty members increased 8% sequentially to approximately 477,000 members, while increasing average basket by 5%. In addition, our loyalty penetration grew quarter-over-quarter to 63.3% compared to 60.7% in Q2. As we have stated before, we are focused on enhancing our consumer experience to maximize customer loyalty and retention across our retail footprint.
Moving on to our New Mexico operations. In August, we announced the grand opening of a medical and recreational dispensary under the R. Greenleaf banner in Hobbs, New Mexico. We acquired the R. Greenleaf banner in February 2022 and have since opened nine additional R. Greenleaf stores across the state. With the most recent opening, our New Mexico footprint stands at 33 dispensaries each serving the needs of both medical patients and recreational customers.
Despite pricing pressure in New Mexico, we generated 10% year-over-year and 5% sequential growth in retail sales in the state and have outpaced overall market growth, increased our share primarily through acquisitions.
We are focused on integrating the assets and implementing our operating playbook to increase same-store sales and drive customer traffic. We continue to believe that New Mexico provides a unique opportunity to address a highly fragmented market and will continue to optimize our operations as we grow market share in the state.
We experienced a 55% sequential increase in customer loyalty members in the third quarter to approximately 144,000 members in New Mexico as we integrated Everest Apothecary into our operations. Similar to Colorado, we believe there is an opportunity to capitalize on customer loyalty and will continue to develop the program across the state.
Our wholesale business grew 41% year-over-year, primarily due to our entry into New Mexico. New Mexico wholesales in quarter three now approximately is 22% of our wholesale business and growing.
In Colorado, we have expanded our wholesale portfolio and our current offerings include flower, pre-rolls and vapes along with bulk distillate.
Schwazze now sells into seven of the 10 largest operators in each state. Our licensed premium pre-roll brand from Lowell Farms is now in over 132 doors in Colorado and has become the number two pre-roll in Colorado by the end of Q3.
Turning to our cultivation and manufacturing operations. Our divisional cultivation leaders have made solid progress on improving both our indoor and outdoor growth, leading to higher flower yields, quality and lower cost of goods. In addition to improved quality, these efforts resulted in a 16% sequential reduction in our average cost of flower in quarter three.
We are in the process of optimizing our inventory across the system through a new ERP implementation across our acquired cultivation and manufacturing facilities. As many of you know, these projects are not quick and easy to implement. They take time and careful diligence to ensure an effective deployment and these efforts will enable us to improve our visibility and control of our inventory levels, enhance supply chain efficiencies, and uncover various cost saving opportunities in the future.
Before passing the call on to Forrest to review our financials in more detail, I'd like to take this opportunity to thank the entire Schwazze team across Colorado and New Mexico. Their dedication to executing our operating playbook to drive results regardless of the challenging market conditions is a testament to the quality and culture of our team.
Forrest, over to you.
Forrest Hoffmaster
Thanks, Nirup.
Jumping right into our results, as a reminder, all financials are in U.S. dollars and variance commentary is on a year-over-year basis unless otherwise stated. Total revenue in the third quarter of 2023 increased 8% to $46.7 million compared to $43.2 million for the same quarter last year. The increase was primarily due to growth from new stores compared to the prior year period and increased wholesale revenue, partially offset by pricing pressure from the proliferation of new licenses in New Mexico.
Gross profit for the quarter was $21.4 million, or 45.9% of total revenue, compared to $22.5 million, or 52% of total revenue in the third quarter of 2022. The decrease in gross margin was primarily driven by a year-to-date true-up expense reclassification from SG&A into cost of goods sold as well as increased lower margin medical sales mix in Colorado and lower initial gross margin from our acquisition of Everest Apothecary's inventory. This was partially offset by improvements to product mix across our retail footprint.
Operating expenses for the third quarter of 2023 were $12.5 million, compared to $11.4 million for the same quarter last year. The increase was primarily due to four-wall SG&A increases associated with 28 additional stores in Colorado and New Mexico that are still ramping. As a result, income from operations for the quarter was $8.9 million, compared to $11.1 million in the third quarter of last year.
Net loss was $0.3 million, compared to net income of $1.8 million for the third quarter of 2023 or 2022.
Adjusted EBITDA for the third quarter of 2023 was $14.1 million, or 30.2% of revenue compared to $15.9 million, or 36.7% of revenue for the same period last year. The decrease in adjusted EBITDA margin was primarily driven by the temporary lower gross margin and higher four-wall SG&A associated with new stores that are still ramping into our system.
We generated positive operating cash flow of $6.9 million, compared to $10.5 million in the third quarter of 2022. As of September 30, 2023, cash and cash equivalents were $19.6 million compared to $38.9 million in -- on December 31, 2022, while operating working capital decreased by $3.5 million to $0.6 million during this period.
Total debt as of September 30, 2023 was $155.1 million, compared to $127.8 million on December 31, 2022.
As Nirup mentioned earlier, we're focused on revenue growth, customer acquisition and generating positive cash flow, all while making further progress on integrating our recent acquisitions to drive operational efficiencies and cost synergies at scale.
In addition, we are in the process of optimizing our inventory through an ERP implementation across our cultivation and manufacturing facilities, which we expect will lead to one-time inventory valuation adjustments as we close out the year. These initiatives will enable us to further -- to recognize further improvements across our business as we continue to deepen our presence in the markets we serve.
I will now turn the call back to Nirup for closing remarks.
Nirup Krishnamurthy
Thanks, Forrest.
Looking ahead to 2024, our strategy remains unchanged. Leverage our operating playbook and further integrate our acquired assets to drive customer acquisition and sales across our expanded footprint while generating cash. We will continue to evaluate opportunities that can enhance our geographic footprint and brand portfolio, and we have proven our ability to execute in competitive environments and we look forward to capitalizing on the opportunities ahead.
That concludes our prepared remarks. I'd now like to pass it back to Sean who will open the call for Q&A. Sean?
Question-and-Answer Session
A - Sean Mansouri
Thanks, Nirup, and Forrest, and thank you everyone for participating in the conference call. We'll now begin the prepared Q&A session. As we gather the queue for live questions, we'll address questions that came in via e-mail over the past couple of weeks.
So, kicking off, you mentioned in response to license proliferation that you're leaning into pricing and promotional efforts in New Mexico to drive traffic and sales. What specific initiatives are you implementing and how long do you anticipate this to drag on gross margin?
Nirup Krishnamurthy
Thanks, Sean. I'll take that one and I'll have our Chairman opine on that as well.
As we discussed on the call, New Mexico sales increased 19% year-over-year in Q3, but the store count was up 76%. So obviously the pie is being shared by a more number of outlets. So we are essentially focusing on running a good operation, increasing our product assortment, improved merchandising within our stores and providing a variety of pricing options for all our customer segments.
So I think that is -- that's something we have to do to make sure we compete with these new licenses, but the same time provide our brand promise, which is providing the best assortment, highest quality and exceptional service in our stores. We'll have to wait and see how long certainly it will take to drive our customers into our stores, but we believe that it is a temporary kind of impact on margins. And as we drive our -- as we implement our operating playbook, we expect New Mexico to be a long-term prospect for us in our footprint.
Hey Justin, do you want to kind of add anything to that?
Justin Dye
Yes. Let me add two comments. I think as you look at New Mexico, there are things that we control and then there are things that Schwazze influences. I would tell you we are disappointed with the regulatory environment as it is today. We believe that it is improving and it will continue to improve in terms of the regulations and enforcement.
And what I mean by that is having out of state product in a number of these new stores, we have seen that with little to no enforcement and we're starting to see the government starting to enforce that and that will improve and that will certainly help those operators who play by the rules and who follow that. We think that's important for the customer so that they know they've got tested product. So that's good for everyone. So we're optimistic it's going to continue to improve and that will help -- that will certainly help our business in terms of sales and margin as we do that.
Now, there are things that we control as well, that we're in process Nirup and the team have a very direct plan to work on offering the best products with a broader assortment than where we -- than what we have today and working out with our people, as well as pricing and promotion, which they have a plan that we're working through today.
And from an investment perspective and from a Board perspective, we believe in New Mexico, we believe in the business, and we're here for the long-term. And we're going to continue to invest in the customer experience and treat it as such. And we're going to continue to work on that. So long-term focus, we're going to keep working with the regulators on enforcement and taking some of the best practices from Colorado. And we're going to continue to improve the in-store experience, which we have room to continue to work on, and obviously working on the synergies with Everest. So we're optimistic, things are going to continue to grow and improve there.
Sean Mansouri
Thanks, Justin. Maybe flip to Colorado here, guys. What are you witnessing from a competitive standpoint in Colorado?
Nirup Krishnamurthy
Let me take that. Competitively, we're not seeing any increase in cultivation licenses, for example. We are seeing the opposite. Cultivation license count in Colorado has come down on the recreational side approximately from 855 licenses down to 655 licenses. And so it's quite a dramatic reduction and we expect that to continue. I think the word in the -- word out in the Street is that more cultivations are going to shutter down over the next quarter or two, and that should help stabilize the market, so to speak. And we are watching that carefully and we'll evaluate that as time goes along here.
On the retail side, we had a couple of new jurisdictions open up licenses. Brownfield opened up with six licenses. And so as these new jurisdictions like opened up, we need to figure out how to compete. We need to get licenses in there and that's part of our game plan going ahead.
And so, our competitors, as I mentioned in the last earnings call have invested in prices -- in pricing at the store level in the first couple of quarters. But in the third quarter, we are seeing that coming back up. So the market is starting to stabilize, but we need to put our foot down and continue to implement our operating playbook and keep our customers happy.
Sean Mansouri
Thanks, Nirup. Given you're in the early stages of integrating your new assets, what's your perspective on future M&A? Will you work to continue optimizing the newly acquired assets before evaluating new targets?
Nirup Krishnamurthy
Yes. I mean, over the last year, we have acquired a significant number of assets across retail, manufacturing, cultivation, and we have opened offshore premise storage facilities to handle our inventory. As you have said in the past, we expect to realize full synergies of acquisitions within 12 months to 15 months. And our main priority right now is to optimize our new assets while driving synergies and driving customer experience to drive revenues and sales across the footprint.
From an M&A standpoint, our -- we will continue to look at opportunities that will enhance our strategy, which is to go deep in each of these states. But our primary focus now is to optimize the host of assets that we have purchased or acquired in the last year.
And Justin, you want to give your perspective on that?
Justin Dye
Yes. I think Nirup, you said it well, a heavy focus on driving synergies and optimizing our operations. So operational excellence with all of the stores, we have work to do there and the team is, we're excited about the opportunity there. We also have opportunities in the supply chain and to continue to use lean processes to drive efficiencies, which we think is a competitive advantage for us. And we think there's more to have and we'll use our size and scale to become very efficient, even more efficient than we are today. So heavy focus there while still remaining open to strategic opportunities, but a heavy focus on optimizing what we have today.
Sean Mansouri
Thanks, Justin. Can any of you expand on the initiatives in place to improve flower yields and quality while lowering input costs?
Nirup Krishnamurthy
I mean, yes, I can. Obviously, as we acquire these gross we have -- it takes a while to integrate them and get them to be in the best shape possible to produce the best results. And that's what we have done with our acquisitions in both Colorado and in New Mexico. We have implemented standardized SOPs for all parts of the growth cycle. We have implemented 5S and then lean practices across all our facilities.
We have also invested in some CapEx in our manufacturing facilities. For example, for pre-roll automation, we switched from manual pre-rolls to automated pre-rolls, which has significantly enhanced quality and costs. And we also ensure that we don't -- we utilize our facilities. For example, we have our cultivation farm at Southern Colorado that has in theory, a short cycle during the summer months where you can't grow a full regular indoor harvest -- indoor growth cycle. So we decided to use auto flower and get a bunch of biomass for our extraction facilities, so optimizing utilization of our facilities, implementing human processes, standardized SOPs and a bunch of other things. And I think we are starting to see the results of that in a quite effective way.
Sean Mansouri
Thanks, Nirup. This next one is probably better for Forrest. Forrest, can you provide additional color on the timing of expected benefits from the new ERP implementation?
ForrestHoffmaster
Yes. Thanks, Sean. As Justin mentioned our integrated supply chain competitive advantage, and in terms of timing, just the short answer is, we're bringing all facilities up onto one platform. Expect to have that rollout complete in late quarter one early quarter two 2024. Yes, at a high level benefits, we've got eight cultivation manufacturing facilities producing over 35 to 40 strains in each state and something close to 200 different SKUs with roughly $31 million, $32 million of total inventory in the system.
So we're working in the store to build our competitive advantage there. We feel like we have a cost advantage to drive informed decisions with insights through real time system that -- and that will free up the additional working capital instead of having it locked up in inventory, improve our retail in stock positions. It'll support our wholesale growth. We're starting to see strong signs in the New Mexico market and improves supply chain efficiencies overall, which should ultimately have a material margin improvement system wide.
As mentioned, Nirup also mentioned these implementations come with write on adjustments both ways, and as we continue to move through ERP implementation, I expect we'll see some kind of adjustments over the coming months as we get to the other side of the roll-outs, just to get our inventory balance straight and loaded into ERP this quarter.
Sean Mansouri
Thanks, Forrest. This next one that came in via e-mail, can you give us an update on the Everest Apothecary integration?
Forrest Hoffmaster
I can take that. Nirup discussed earlier in his opening comments, it's going well. In quarter three, we've had our full attention on integration, creating the synergies there with that banner while addressing the overall New Mexico competitive landscape that Nirup talked more about, as did Justin.
But within the four-walls store conditions, retail executions improving, as are the end stocks, while we rationalize SKUs getting discontinuing slow moving items and bringing in a broader, deeper assortment. And we're starting to see meaningful sequential basket improvement over the last few months. We just consolidated the facilities and moved them over to our ERP platform, so they were one of the early facilities onto the ERP system, which will help us leverage our costs and create greater visibility into the real cost of manufacturing.
And while we're still working through the acquired inventory, we'll ultimately be able to realize those gains from consolidation and lower overhead with what we believe will be better service to retail and wholesale operations. So overall, so far so good.
Sean Mansouri
Awesome. Great to hear. This could go to either of you. What are your thoughts on regulation enforcement in New Mexico and that Schwazze has taken any initiative to support this, recognizing that Justin covered some of this as well.
Nirup Krishnamurthy
Yes. Justin has already covered some of that. We're -- Dan Pabon is our Chief Regulatory Officer, Chief Policy and Regulatory Officer, and he and I are working closely with the state's Cannabis Control Division to review guidelines and regulations to reduce negative impacts of the illicit market and ensure compliant operations. Illicit sales, especially New Mexico pose a safety threat to all consumers. We are committed to supporting the state however we can as the state's program develops and we -- off late recent activity, we are seeing -- we're hopeful of better enforcement and ensuring that the consumers get the right products for consumption.
Sean Mansouri
Thanks, Nirup. And last one for this prepared Q&A, what needs to happen to get the industry back into a growth phase?
Nirup Krishnamurthy
I'll let Justin handle that one.
Justin Dye
Yes. That's a great question. It's -- I think it's a fairly virtuous cycle and reasonably -- and I think it's fairly straightforward in terms of what's going to happen. I mean if you look at where cannabis is today, let's just look at how it's valued today. If you look at sort of the median enterprise value on 2023 to 2024 multiples, they're anywhere from 4x to 7x.
If you look at the S&P 500 and you take out energy, they're in the mid-teens in terms of valuation. So this sector has probably 2x to 3x upside in terms of multiple growth once we start getting capital in, and I'll cover that here in a second. And then, if you look at the growth, the sector is growing, projected to grow at 15%, 16% for the next several years, where if you look at the rest of the economy, it's projected to grow at 4%, 5%. So you have massive growth. We're going to generate another $20 billion, $25 billion over the next couple of years in this business. So I am as bullish on this sector as I've ever been.
And you know what? We just haven't gotten the key pieces in place yet, but they're coming. So what needs to happen? One is we need federal common sense reform, which we will get, I believe. I think we're going to get rescheduling. I think that is likely to happen mid next year. There's no guarantee, but if you look at all how people are incented and why that would happen, it certainly looks like that would.
That will then probably trigger more state reforms like we just saw in Ohio, where through a ballot initiative, they just approved recreational cannabis in the heartland of the U.S., which is a key driver for the rest of the U.S., which I think is a very, very big deal. That's going to drive more capital, and more capital coming into the system both from a debt and equity perspective is going to lower the cost of capital for cannabis companies that are looking to borrow or raise equity, which is then going to drive higher stock prices, which is then going to allow larger players to have a stock currency to do more M&A, which will drive synergies and drive more operational efficiencies.
So it's sort of this virtuous cycle where you're going to see -- you are going to continue to see this thing grow. And I think we're -- frankly, we're at the bottom of the cycle. And I think over the next couple years we're going to see things improve. And if you look at how the larger players over the last really 6 to 12 months have started really converting operations -- cash flow from operations, really talks about the quality of the EBITDA and some of the larger players make the headlines, which then eventually will trickle down to very profitable smaller regional players such as ourselves. So I'm bullish on it. I think we have to be patient.
The real story for Schwazze is to continue to execute operationally at retail, wholesale, and driving our supply chain and continue to grow a really profitable business. And our shareholders, we're going to take a long-term view on this and build a really great company, which is what we set out to do. And I think the markets will reward us. We just need to have some patience.
Sean Mansouri
Appreciate that, Justin. That's a wrap from my side with the questions that have come in via e-mail. Operator, would you like to open it up for live Q&A, please?
Operator
Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. [Operator Instructions].
There are no questions at this time.
Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for joining. You may now disconnect.
For further details see:
Medicine Man Technologies, Inc. (SHWZ) Q3 2023 Earnings Call Transcript