Curaleaf Holdings Inc

CNSX:CURA

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon everyone, and welcome to the Curaleaf Holdings Inc. First Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today’s event is being recorded.

At this time, I’d like to turn the floor over to Camilo Lyon, Chief Investment Officer. Please go ahead.

[Camilo Lyon, Chief Investment Officer]

Good afternoon everyone, and welcome to Curaleaf Holdings' first quarter 2023 conference call. Today, we are joined by Executive Chairman, Boris Jordan; Chief Executive Officer, Matt Darin; and Chief Financial Officer, Ed Kremer.

Before we begin, I’d like to remind everyone that the comments on today's call will include forward-looking statements within the meaning of Canadian and United States securities laws, which, by their very nature, involve estimates, projections, plans, goals, forecasts, and assumptions, including the successful integration of acquisitions and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements on certain material factors or assumptions that were applied in drawing a conclusion or making a forecast in such statements.

These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. We undertake no obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise, except as required by applicable law. Additional information about the material factors and assumptions forming the basis of the forward-looking statements and risk factors can be found in the company's filings and press releases on SEDAR and the Canadian Securities Exchange.

During today's conference call, in order to provide greater transparency regarding Curaleaf's operating performance, we will refer to certain non-GAAP financial measures and non-GAAP financial ratios that involve adjustments to GAAP results. Such non-GAAP measures and ratios do not have a standardized meaning under U.S. GAAP.

Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by U.S. GAAP, should not be considered measures of Curaleaf's liquidity, and are unlikely to be comparable to non-GAAP financial measures provided by other companies.

Any non-GAAP financial measures referenced on this call are reconciled to the most directly comparable U.S. GAAP financial measures under the heading "Reconciliation of Non-GAAP Financial Measures" in our earnings press release issued today and available on our Investors Relations website at ir.curaleaf.com.

With that, I’ll turn the call over to Executive Chairman, Boris Jordan. Boris?

[Boris Jordan, Executive Chairman]

Thank you, Camilo. Good afternoon everyone, and thank you for joining us to discuss our first quarter 2023 results. Since it has only been a few weeks since our last earnings call, we will take a slightly different tact today. Given all the negative sentiment around the industry, a lot of which is not really justified, I want to focus on the many catalysts we envision both internationally and domestically.

There are exciting things happening right now and many more on the horizon and these secular growth drivers often get lost and all the noise around federal reform and the challenging operating environment we are currently in. Today's equity valuations do not appropriately reflect the opportunity in cannabis as this is still a dynamic and fast growing industry with a long and bright future.

Matt will then discuss the myriad of operational initiatives we are implementing to improve efficiency and reduce costs. We know that expanding our margins during these tougher times will leave us with well positioned for highly profitable growth as the industry normalizes. Ed will close with a review of our quarter one results.

Despite our commitment to efficiency, Curaleaf is very much a growth company, and our solid start to 2023 is evidence of just that. I'm pleased to report first quarter year-over-year revenue grew 14% to $336.5 million compared to 296 million last year, beating our guidance of low-double-digit sales growth.

Adjusted gross margin was 48% and adjusted EBITDA margin was 22%, both exceeding consensus estimates. Based on the productivity and efficiency measures we have implemented across the organization, we anticipate margins will expand throughout the year. We ended the first quarter with 116 million of cash in our balance sheet and generated 31 million in operating cash flow from continuing operations.

Also Curaleaf has access to approximately 50 million in secured financing that can be used to bolster our working capital should the need arise. Since our fourth quarter call, two weeks ago, I've been in Europe meeting with our international team analyzing the business and contemplating new opportunities. Curaleaf is the only MSO that has embraced the massive European market initially investing in the leading platform two years ago. It is enormously gratifying to see that the market is now rapidly advancing as we envisioned as evidenced by the 130% year-over-year growth and quarter one registered in our European operations.

I'm even more excited about the revenue and profit of our International segment will contribute top Curaleaf over the next 3 years. This remains meaningfully underappreciated by the investment community, but I suspect that as Germany launches and other countries follow suit, we will get more credit for these bold moves. While still evolving Germany's [draft regulations] [ph] entail a two-pillar system, with pillar 1 focused on expanding the medical market, and pillar 2 aimed at the adult use market.

Pillar 1 is setting up to be a Goldilocks scenario for the established players like our recently acquired brand Four 20 Pharma. Currently, two-thirds of the German market is comprised of just five players. One of which is our company Four 20 Pharma with a roughly 15% to 20% share. There are an estimated 200,000 medical cannabis patients in the country out of a population of 84 million people.

However, many more citizens have applied for access only to be denied by the high barriers to getting prescriptions from a doctor. Under the current draft, pillar 1 would immediately eliminate this friction for patients by removing cannabis from the narcotics list, thus allowing doctors to more freely prescribe while also giving consumers the comfort of knowing they are not part of a monitored national database. This proposal would also allow digital telemedicine appointments and faster delivery times, simplifying patient access, compared to the cumbersome in-person and paper-based process mandated today.

Removing these hurdles would undoubtedly accelerate patient enrollment just as we have seen in the U.S. when medical states expand the list of qualifying conditions. As we assess and plan for how this market may develop, we look at Germany and compare it to established U.S. Medical markets such as Florida, which has a current penetration rate of 3.8%. Assuming a similar participation rate in Germany, implies a total patient population of over 3 million, which would be a 15-fold increase from today's levels.

We are conservatively assuming total patient growth of 3x to 5x, which still implies a 1.5 billion euro market opportunity over the next two years. We are investing ahead of this massive opportunity to drive share and we intend to leverage the Four 20 brand, which is known for consistent high quality high THC potency.

Given that medical patients are eligible for insurance reimbursements in Germany, these assumptions may well prove quite conservative. Building a well-recognized brand in the medical market ahead of adult use will give us an advantage when the program is ultimately launched.

In addition to our production coming out of Portugal, we have augmented our supply chain with an exclusive multi-year partnership with the leading Canadian supplier of high-end flower to ensure we provide the market with consistent high grade product as the market accelerates.

The [Technical Difficulty] market grew 75% year-over-year in quarter one, and we continue to streamline the patient final process by incorporating technology and software, helping remove friction from the customer acquisition. We are also bringing our latest product innovations from the U.S. to this market. Over the coming months, we will introduce our newly formulated edibles and medical vapes to the UK, and there is nothing comparable to these products available there today. This should further cement our lead in this high growth yet still nascent market and establish Curaleaf as the most well-known and trusted brand from day one.

We are investing prudently today throughout our International segment setting the stage for robust growth in 2024, 2025, and 2026 as cannabis adoption accelerates across Europe. I could not be more excited about this opportunity and feel highly confident that this will be a huge strategic advantage that we will ultimately pay big dividends for our shareholders.

We also have many exciting growth drivers domestically and Curaleaf is well-positioned to capitalize of near-term, medium, and long-term state level catalysts. In Connecticut, our two adult used stores continue to ramp nicely and we expect our other two stores to be improved within the next 30 to 60 days.

In Maryland, we are eagerly awaiting the July 1 launch of adult use program with four highly productive stores, a robust wholesale presence, Maryland will be a very good market for Curaleaf. New York is another important opportunity. This is a market where we have a long held number 1 share position. [Track regulations] [ph] came out last week, and while the OCM has offered some concessions to the existing ROs, the industry is demanding more.

The current regulations are hurting the hemp farmers and [card license recipients] [ph] they were designed to help. These arbitrary rules only benefit the illicit market, which is driving in the absence of legal competition. We along with other market participants are steadfast in our legal position and look forward to a quick resolution so the legal market can grow equitably and thrive.

We are hopeful that we can begin selling in adult used market by quarter four and [indiscernible], which will be an important step towards elevating New York into a $5 billion in the pinnacle of East Coast cannabis. Over the next 2 to 3 years, important Curaleaf states, including Florida, Ohio, and Pennsylvania are likely to convert to adult use. According to BDSA, these three markets combined are estimated to generate over 8.5 billion in sales by 2027, and we will be ready to capitalize.

Beyond that, we have applied or will be applying for licenses in Texas, Alabama, Kentucky, and North Carolina, which represents further growth opportunities that we are eagerly anticipating. We are committed to efficient expansion and highly profitable growth and believe that we are just beginning to tap into the possibilities of this rapidly emerging industry.

We continue to expect 2023 revenue will grow low to mid-single digits compared to 2022 revenue of 1.3 billion and project solid adjusted EBITDA margins in the mid-20% range, resulting in free cash flow generation of 50 million to 60 million after anticipated investments of $70 million into our business.

With that, I'll turn the call over to our CEO, Matt Darin.

[Matt Darin, Chief Executive Officer]

Thanks, Boris. Over the past 12 months, we have made significant strides in streamlining our business. Since I moved into the CEO role one year ago, we've moved decisively and with urgency to maximize opportunities in high growth markets, while scaling back from structurally unsound markets. We are laser focused on operating efficiencies in every aspect of our business, including our cultivation and processing operations, retail store productivity, and shared services both in the U.S. and Europe.

Exiting unprofitable states was the first step, but certainly not the last. We are establishing a lean asset base from which we will drive operating leverage, margin improvements, and cash generation. I will touch on three operational initiatives that are underway and that are already contributing to productivity and efficiency gains that will build throughout the year. These three initiatives are: inventory management, automation, and genetics.

First is inventory management. While our inventory increased slightly from the end of 2022 as we ramped up for Four 20 spring season and the launch of JAMS our new Edibles brand. We are taking a number of actions to right size our inventory. We are in a strong position to execute on this critical priority with the strength of our retail business and ability to further leverage our own branded products.

We are successfully increasing vertical mix in the battleground markets of Illinois, Pennsylvania, and Arizona. We are at or approaching the 40% regulatory limit in Illinois in most locations and are now exceeding 50% vertical mix in Pennsylvania with room to grow. There are catalysts on the horizon in the wholesale business as well, with new dispensaries opening in New Jersey and Illinois, growth in new adult use markets such as Connecticut, positive trends in Massachusetts and Missouri, and the pending adult use launch in Maryland.

Strong inventory management starts with an excellent sales, inventory and operations planning process. We've invested in systems and personnel that enabled us to forecast demand and plan inventory production with greater precision. Our ERP implementation is progressing state-by-state and when complete will be the first system with real time inventory data direct from all seed to sale systems.

We continue to refine our cultivation methods to focus not only on overall yields, but the ratio of [buds to trim] [ph] with a focus on high quality, high potency buds, and reduced trim output. I am pleased that both our potencies and buds to trim ratios are the best they've ever been with more opportunity for improvement.

We are also reducing redundant or inefficient capacity to further optimize our cost structure. We've closed our Amesbury facility in Massachusetts, our Belmar facility in New Jersey, and our Homestead outdoor grow in Florida. Three older sites that have been replaced by newer, more efficient facilities. We will be continuously evaluating each site to ensure they are earning their cost of capital. While we have more work to do, I am confident in our plan to reduce inventory and to match demands to production.

Second, we continue to invest in automation equipment in our Tier 1 markets where the return on investment is measured in months, not years. The landscape of automation options has improved significantly over the past several years and we have automated numerous processes in our supply chain from cultivation pre-roll vape and edibles production and packaging. We have migrated to mylar bags for most products and will continue this move to reduce cost and environmental impact.

In Florida, we're already seeing the benefits of a state of the art vape filling and capping machine and we'll be rolling this out in Massachusetts and Arizona soon. In New Jersey, we've automated gummy filling and packaging in anticipation of the launch of the JAMS edible lines in early third quarter. In aggregate, the savings to our COGS from automation is estimated at $15 million over the next 12 months, that's over a 100 basis points of gross margin contribution.

Third is our focus on genetics and strain diversity. We are centralizing our breeding process for greater efficiencies around our new genetics program and also introducing new, high potency strains with unique for proprietary genetics. We have a very robust pipeline of new genetics that are in production, but have not yet hit the market some of which are unique cultivars exclusive to Curaleaf.

We are using the same innovative approach we pursued in other product categories and applying it to cultivation. This effort will reduce our third-party purchases as we create a more diverse rotation of flower strains, something we know our consumer likes. These actions are central to achieving operational excellence, and while changes will happen over the course of the year, investments we are making today create a solid foundation that positions us for long-term success.

I would like to address our progress on cost savings and expense controls. We exceeded our cost savings initiative of $60 million and continued to reduce expenditures in COGS and SG&A. We are leaving no stone unturned as we attack every expense category from travel and entertainment to third-party lab testing and more.

With that said, we are continuing to invest where needed. We are spending considerable time and money advocating for our industry in Washington, D.C. as we inch closer to federal reform. While this comes at a cost, this is what industry leadership looks like to us and it's the right and necessary investment to make for the advancement of our industry. We call on the other leaders of our industry to step-up and do their part as well.

Shifting gears, I want to briefly touch on a few state highlights during the quarter. We are seeing strong trends in our retail business. We completed 3.33 million transactions in the first quarter serving 934,000 customers and sold 10.3 million units. Despite the challenging macro environment and continued pressure on pricing and average order values, we are seeing positive movements in a number of key markets.

In Arizona, we had a record breaking quarter and are exceeding our internal projections. AUR per Curaleaf increased mid-single-digits, while market pricing according to BDSA was down sequentially. We are seeing strong performance in a number of Northeast markets. New Jersey increased 55% year-over-year. We launched Grassroots and Find to strong reception. And our Bordentown location continues to ramp well since opening in November.

In Connecticut, we converted two of our stores to adult use with our remaining two set to open over the next 30 days to 60 days. Adult use sales in this state also continued to show a solid ramp as awareness increases and we expand our product assortment.

In Massachusetts, AUR per Curaleaf [indiscernible] the market trend increasing in Q1 compared to the overall market that continued seeing sequential price declines. We attribute this to the introduction of Grassroots as demand for high quality flower is strong and selling out. We see many positive indicators in our business that reinforce our growth focus strategy.

Coupling this with the work we are doing to tighten up all aspects of our operations, including retail, wholesale, cultivation, and production will propel us down the path of higher profitability and cash generation over the coming quarters and years. The future is bright for Curaleaf.

With that, I'll turn the call over to our CFO, Ed Kremer. Ed?***

[Ed Kremer, Chief Financial Officer]

Thank you, Matt. Today, I'll review our Q1 2023 results and provide an update on our outlook. Total revenue for the first quarter was $336.5 million, representing a year-over-year increase of 14%. Growth was driven by New Jersey adult use, Arizona retail strength, the addition of Tryke, new store openings in Florida, and 53% growth in our International segment.

By channel, retail revenue was 273 million, compared to 225 million in the first quarter of 2022, up 21% year-over-year. Wholesale revenue decreased 11% year-over-year to 62 million and represented 18% of total revenue.

Looking at our consumer metrics, transactions remained healthy in the first quarter and were up 14% sequentially from Q4, partially offset by a 7% decline in average order value. Our first quarter gross profit was $161 million, resulting in 48% gross margin. Adjusted gross profit was 162 million. Sequentially, Q1 adjusted gross margin decreased 80 basis points, compared to the fourth quarter largely due to price compression in certain markets.

SG&A expenses were 112 million in the first quarter and increased 12 million from the year ago period. The year-over-year increase in SG&A, primarily reflects operating expenses associated with the addition of Tryke, Four 20 Pharma, and new store openings. SG&A as a percentage of revenue was 33% in the first quarter, down 60 basis points, compared to the year ago period.

Our first quarter SG&A included approximately 8 million of add back versus 6 million in the prior year with the increase driven by consulting and legal fees associated with our GAAP conversion process and expenses associated with acquisitions. Our core SG&A rate in Q1 was 31%, a decrease of 110 basis points year-over-year as we are beginning to realize some of the benefits of the expense reduction actions we began taking in November coupled with leverage on stronger sales.

First quarter net loss was 56 million, which included 10 million of losses from discontinued operations. Net loss per share from continuing operations was $0.06. Adjusted EBITDA for the first quarter was $73 million, compared $76 million last year, a 4% decrease resulting in AEBITDA margin of 22% and 26% respectively. Sequentially, our adjusted EBITDA margin decreased 60 basis points from Q4, due to gross margin contraction.

Turning to our balance sheet and cash flow. We ended the quarter with cash and cash equivalents of 116 million. Inventory from continuing operations increased 20 million or 8% compared to the fourth quarter, largely driven by build ahead of Four 20 and the launch of our JAMS, our new edibles line.

Net capital expenditures in the quarter were 26 million. We expect CapEx spend to be front half loaded and then decelerate in the back half of the year. As Boris and Matt mentioned, we are prudently investing today in the future growth opportunities we see across the international and domestic landscape.

We continue to expect 2023 CapEx to be approximately 70 million or half of last year's expenditures. Our outstanding debt was 594 million net of an amortized debt discounts of which 80% is not due until December 2026. We ended the fourth quarter with 718 million fully diluted shares outstanding. We generated $14 million of cash flow from operations. Excluding a $16 million use of cash from our discontinued operations, cash flow from continuing operations was 31 million. Free cash flow from continuing operations was 5 million.

While we are comfortable with our ability to fund our growth initiatives and pay all of our obligations, the company has access to approximately $50 million of secured financing that can be used to bolster our working capital should the need arise. We are off to a good start for the year and demand for cannabis remains robust, but the current operating environment still presents its share of headwinds such as elevated promotional activity in various states.

We are well-equipped to navigate these bumps in the road, yet we're also mindful of the pockets of distress in the market. As such, we are reiterating our fiscal 2023 guidance of low to mid-single digit revenue growth versus comparable $1.3 billion revenue base in 2022, which excludes discontinued operations. We continue to expect full-year adjusted EBITDA margin to be in the mid-20% range.

For Q2, we are comfortable with the current consensus estimate of approximately $340 million in revenue, which represents comparable year-over-year growth of 4% versus Q2 of 2022 revenue of 327 million, which excludes discontinued operations. We continue to expect to generate over $100 million in operating cash and 50 million to 60 million in free cash flow this year with inventory at work down being a key driver of overall working capital improvement.

To this point, we expect to see inventory as a percentage of sales to improve to 15%. Lastly, I want to reiterate that the cadence of our cash flows will trough in Q2 after making tax payments and paying the balance associated with this year's Bloom obligation. Then cash will begin rebuilding in Q3 with Q4 representing the largest cash generating quarter.

And with that, I'll turn the call back over to the operator to open the line for questions.

[Operator]

[Operator Instructions] Our first question today comes from Aaron Grey from Alliance Global Partners. Please go ahead with your question.

[Aaron Grey, Alliance Global Partners]

Hey, good evening and thank you for the questions. So, first one for me. I want to ask a high level one, Boris. In the past, we spoken towards a balance of, kind of market share and top line growth, which you had been big on and then a little bit more of a shift to margin just because what's happened in the marketplace. So, obviously, we've seen this shift more recently as you exited some investment markets and increased verticalization. I want to get some more color in terms of how you look to balance that in your existing markets going forward to drive market share gains, particularly from more of a wholesale perspective as the states start to normalize? And would it be some more comfortable doing that just given the current dynamics? Thanks.

[Boris Jordan, Executive Chairman]

I will give a macro picture and I'll hand over to Matt to [proceed about] [ph] the business day-to-day. What we've done is, we've just made an alignment given market circumstances to focus right now on building up our margins. In order to generate cash. Cash is important in the current environment.

And as we said, we intend to finish the year with $50 million to $60 million of free cash after all the, [indiscernible] relatively heavy obligations during this year on both tax and some of the acquisitions we've made. So, we think that's a good result of getting to that mid-25 level.

However, as I started the call today, we're really focused on growth. And the growth opportunities for Curaleaf going into 2024, 2025 and 2026 are quite substantial. And so, we still have significant CapEx that we're making this year. And to the tune of $7 million, we'll be focusing primarily on our European assets, but also continuing to build-out in those markets like Arizona and Florida and others where we have significant market share where we feel we can grow our market share further.

Matt, I don't know if you want to add to that?

[Matt Darin, Chief Executive Officer]

Yes. So, specifically on the wholesale side, we're certainly focused on some of our key markets where we are in new doors open, specifically New Jersey and Illinois and really focused on capitalizing that on those opportunities and continue to be focused on rounding out our brand portfolio. That's why we've launched the JAMS edible brand, and a number of other different products across the segment there.

So, I can also say, we are seeing some real positive signs in a few markets that have had its challenges over the past number of quarters, namely Massachusetts. Massachusetts is a market that got very oversupplied, but we're now seeing some really strong opportunities when we have our Grassroots flower when then hits the menu it sold out in a matter of hours.

So, seeing some real opportunities to kind of ramp up into that. Also, seeing markets like Missouri that been a great success story and we just see huge wholesale opportunity in the Missouri market as that continues to grow into a billion dollar market.

[Aaron Grey, Alliance Global Partners]

Great. Thanks for that color. And quick follow-up for me just in terms of New York rates. So, I know you mentioned in your prepared remarks. Obviously, updated rates came out. Seems like you're not fully satisfied, you know, able to open some stores sooner still has a pretty high conversion fee. So, you know, how do you think about the timing of when we might get some type of resolution and have they been receptive towards that? And then how big of a factor would it be to their ability to crack down on the illicit market in terms of making it appealing for your decision to then participate and pay that conversion fee to come to the New York adult use marketplace? Thanks.

[Boris Jordan, Executive Chairman]

I think that's playing a big role, that's fees that they want to charge. From our perspective, there's no enforcement on the adult use market. It's going to be very difficult to pay any fee in New York with the illicit market you know, going crazy. So, I mean, we've seen some movement from the governor with new legislation regulations posted, giving the regulator more rights to enforce.

Frankly, we thought they had them from the very beginning anyway. We still do. And it's really a question of whether or not they're prepared to do that. The one good news is, is at least on the East Coast, what we've seen is once the adult use market gets going, the legal adult use market.

Once there's a significant amount of penetration with good quality stores and good quality product, you do start seeing people migrating over to the legitimate market for a whole host of reasons, both the fact that they don't want to break the law, but more importantly, they want to have products that can be tested. You probably also recently, you know there's articles about cannabis up there being laced with fentanyl. You're not going to find that regulated stores. And so, I do think that the more we see unfortunate things like that, you will see people migrate into the stores.

Regarding the negotiations, yes, we're not pleased at the moment because the state isn't even fulfilling their legal obligations with the law that they passed. And so, all we're asking the state to do is to actually abide by the laws that were passed in the state of, you know, two years ago when the adult use program was originally approved. And that's where we're having our issues. But we are making progress with negotiating with them. They've already made some moves here when they published the rules. As you know, those rules are now in common period. So, we will be in negotiations with the state.

We hope over the next month or so that we will come out to the program that we think hopefully between the state and ourselves that's equitable, addressing the issues the state has, addresses those issues that we have, and will let us get into the market here in the fourth quarter. The state, New York needs wholesalers. I think that the state really needs companies like Curaleaf to get their products on the shelves, because the quality of the products on the shelves today is very, very low because it's largely being grown at outdoor hemp farm, and so it doesn't meet the criteria that the customers want and the state wants.

So, I think there's impedance in the setup on both sides to try to get the program launched, but it's a process. And we're going through that process now. And as I said in the call, we do hope that [Technical Difficulty] wholesale and a little bit of retail, but we should get going here in the fourth quarter just, you know, assuming negotiations go well.

[Aaron Grey, Alliance Global Partners]

Appreciate that color. Very helpful and I'll jump back in the queue.

[Operator]

Our next question comes from Matt McGinley from Needham. Please go ahead with your question.

[Matt McGinley, Needham]

Thank you. And thanks for the color on the inventory plan for the year. You already noted the drivers of the increase the first quarter. But I just want to make sure that, is the first quarter going to be the peak for those inventory levels? And then on taxes payable, last year, I think your gross taxes were about – your payments were about 108 million and your net taxes were around 60 with the deferrals. So, those amounts look similar this year.

[Ed Kremer, Chief Financial Officer]

Yes, Matt. Thanks. This is Ed. The latter part of your question is, yes; and the first part of your question is also, yes. With the inventory levels are at their highest at the end of the first quarter, we believe and will expect to unlock upwards of $40 million of working capital lift just from our inventory by the end of the year.

So, we've already seen it to start to come down in April. And we continue to take that down as we thin out our rooms as we reduce our inventory from the conversion to finished goods that we built up to support these launches. And we will continue to drive that inventory down as the key initiative and we're already seeing those results.

[Matt McGinley, Needham]

Great. And assuming that the ballot initiative in Florida passes the Supreme Court review and will be on the ballot in 2024, what are you doing today or preparing to do to work in concert with the other operators in the state to build the support for that to pass? I know that one operator funded the entire signature campaign. And I guess I'm a little concerned that if there isn't more of a group effort, you all might not learn the lesson that it should be a coordinated effort until it fails on election day. So, you know that the leadership you're advising at the federal level and the expense around that, what are you doing to further this and make sure that it gets through in Florida?

[Boris Jordan, Executive Chairman]

Well, I think Matt, I'll start and I'll let Matt add to it. Obviously, we are very, very poor adult use launch in Florida. Curaleaf has historically taken the brunt of a lot of the lobbying not only at the federal level, but a lot of the state levels and our expenditures run very, very high compared to other companies.

Obviously, Trulieve is the largest operator in Florida that's taken the mantle in Florida, but we are definitely in coordination in terms of our support in terms of getting signatures to our stores. We are very supportive of everything that [Kim] [ph] is doing, but we kind of feel that we've borne, you know, at least from a financial perspective that we have done a lot around the country. And you add up everything we've done at state levels, whether it be New Jersey, New York, and other places, we're leading in New York, we led to New Jersey. We were very impressive in Illinois, obviously Arizona.

So, we've done our bit to get a lot of these states and spent real dollars in those states, as well as at the federal level. We have very significant dollars going this year again at the federal level for spending. And so, I think the industry, there's some players that are taking the mantle in one location, others in another location. And so, but we are very, very supportive of everything that [she's] [ph] been doing and we'll continue to support it through whatever means we can. But financially, our focus has been federal in other states.

[Matt McGinley, Needham]

Okay. Thank you.

[Operator]

Our next question comes from Scott Fortune from ROTH MKM. Please go ahead with your question.

[Scott Fortune, ROTH MKM]

Yes, good afternoon. And thanks for the questions. I appreciate the color on the international side Boris, but just want to get sense for, kind of that segments, the emphasis there. And how much of that is spending for CapEx, you have a $70 million budget in CapEx for the year, but how kind of step us through the CapEx need to build that out ahead of primarily the 2024 ramp in revenues from that standpoint? That'd be helpful.

[Boris Jordan, Executive Chairman]

What we did to meet our obligations for 2024 given the balance we expect particularly in Germany, but also with the accelerated growth in the UK is that we did two things. The first is we're investing in our Portuguese facility. We will shortly be announcing a transaction in Portugal to increase our capacity on the – particularly on the drying and processing side because we have to be EU GMP certified.

So, we are we are about to do something in that space you'll hear from us. And we also just literally this week signed a long-term agreement, a multi-year agreement with one of the largest providers of EU GMP certified flower. Coming into Europe now and we singed that on an exclusive basis. So, there will be, you know that will help us dramatically. We'll actually create a shortage for other players because up until now they've been supplying many other players, but we, sort of took the initiative to sign a deal with them.

So, in that way, at least over the next 24 months, while we continue to build out our facilities in Portugal, we have supplied enough flower and product on about a 50/50 basis where we'll be providing about 50% of the products ourselves to our facilities and we'll be bringing in 50% on multi-year contract that we signed with one of the biggest providers from Canada. So, we're fully ready for what we think will be a 3x to 5x increase in our market in Germany.

As I said, the numbers couldn't make that much bigger, but we're anticipating about a 3% to 5% we're trying to be conservative percent increase. And our U.K. business continues to grow over 100% per year every year. So, that's continuing to accelerate as well. So, we feel like right now, we have the product supply either it'd be through our contracts or through our facilities in Portugal to be able to supply the market.

[Scott Fortune, ROTH MKM]

Okay. And just to follow – keep on that to follow-up on that. The key is in the access, right? There seems to be the demand there. You know, from a medical, you get prescription, and you have to see a specialist to get that reimbursed. But you're saying the steps that you're taking from Telehealth that you're going to be able to have more doctors with that education now to start prescribing, you know, and since [to direct] [ph] for the [medical status] [ph]. You can accept a few..

[Boris Jordan, Executive Chairman]

Yeah. The amount of doctors that are going to be prescribing is going to, you know, quintuple, compared to what it is now, but more importantly, I think that there was a couple of hundred thousand patients that got rejected by the program because of the restrictions on the program today. Those restrictions are being lifted. So, there's only 300,000 patients period. Those prescriptions will be lifted.

So, even without further marketing or awareness. You're going to get almost a doubling overnight because of all the people that have been rejected by the program that obviously went to the illicit market. Because of the difficulty in getting a prescription in Germany today. So, we're very confident that between the increase in doctors and telemedicine, [indiscernible] will be fully digital. You won't need physical documents anymore.

And there are several companies that are already up and going like Algea Care, in Germany that are already operational today on the basis of what the government is regulating that will almost immediately be able to start providing both doctors and marketplaces to sell products. So, we're very, very – I think the market in Germany is getting ready. The key problem in Germany is going to be product because EU GMP certification is very, very difficult to get.

A lot of product failures etcetera, which is why we've really focused the last two years, especially the last 6 months since we since legislation started to be discussed in making sure we have the supply chain to meet that demand. Those companies that are going to have the product are going to be the ones that are going to win. And what we're really doing is trying to make sure our brand is front and center so that as we move into adult use in 2026 and 2027, our brand will be very well recognized in that very large market.

[Scott Fortune, ROTH MKM]

Thanks. I really appreciate the color. I will jump into the queue.

[Operator]

Our next question comes from [Yuan Tan from Canaccord Genuity] [ph]. Please go ahead with your question.

[Unidentified Analyst]

Yeah. Good evening, everyone. This is [Yuan Tan] [ph] on for Matt Bottomley. Thank you for taking my question. I just wanted to start talking about with the results of this quarter. On a sequential basis, wholesale revenues came down by 8% and now that the wholesale operations have been pulled out of some of the unprofitable states like California, Colorado, and Oregon, I guess, could you comment on which markets contributed to the overall sequential decline? And if the trend of declining wholesale revenues continue, do you foresee more pullbacks from additional states in the future?

[Boris Jordan, Executive Chairman]

So, as it relates to the wholesale business, as we've talked about previously, one of our top focuses is vertical mix in our retail stores and really working behind the strength of our retail business, which we continue to see really positive signs in terms of traffic and different trends. So that continues to be a top priority in an environment where many of the wholesale markets are still working through oversupply in a bunch of different areas.

With that said, I do believe there are going to be opportunities in a number of different markets for wholesale expansion. There's a dynamic at play where you have a number of markets that have not had new dispensaries open up in large [Quantitude] [ph] for several years now, but those are starting to happen. And some of our strongest markets, places like New Jersey and Illinois is two examples.

We're also looking forward to some catalysts on the horizon with Maryland and really exciting wholesale opportunities is that adult use market comes online on July 1 and continued opportunities in places like Connecticut as well with that adult use market that continues to ramp up as you see more product assortment in selection.

So, I do see strong opportunities to continue to build back that wholesale business as we exited some of those western markets and have really, kind of focus the business on more profitable sustainable markets.

[Unidentified Analyst]

Okay. If I could just follow-up to that question with regards to the margins, especially with the balance of the year, in relation to the gross annualized run rate savings of 60 million, could you speak on the split of this number between SG&A and COGS? I guess, just wanted to gain some insight there in terms of how we should think about the margins going forward for the rest of 2023?

[Matt Darin, Chief Executive Officer]

Yes, [Yuan] [ph]. I'll take that. Thanks for the question. Look, there's certainly savings above the line and below the line and you should think about it in terms of probably more like one-third above two-thirds below, give or take. In terms of sort of the breakdown of where the cost savings are coming from. And that's just on a run rate basis, right? We obviously have additional expenses associated with the acquisitions that we brought on.

[Unidentified Analyst]

Okay. Thank you for the color. I'll jump back into the queue.

[Boris Jordan, Executive Chairman]

Thank you.

[Operator]

And our next question comes from Andrew Partheniou from Stifel JMP. Please go ahead with your question.

[Andrew Partheniou, Stifel JMP]

Hi, good evening. Thanks for taking my question. Maybe continuing on the margin focusing on gross margin here. You've got a few moving parts, the inventory monetization, cost savings, and maybe more sales in higher margin states. So, wondering if you can, kind of compartmentalize this or maybe discuss how should we think about this? Could your cost savings potentially offset the potential – any potential pressure from inventory monetization. And then more sales in Illinois, New Jersey, higher margin states could give you that margin lift? Or is there another way that we should be thinking about this? And then maybe more specifically about Illinois, New Jersey, if you could talk about how many new stores do you think could open this year?

[Boris Jordan, Executive Chairman]

Yes. Let me take the first part, and I'll let Matt answer sort of, I guess the part around the store growth. But the way you should sort of think about it, Andrew, is just a couple of things, right? I mean, you'll see that our increase in vertical mix continues to improve. We've certainly seen that in Illinois. We continue to drive that up and get it right up to the regulatory cap. We're improving our vertical mix in Arizona, and other states.

You know that Maryland is coming online coupled with that vertical mix upsetting obviously the wholesale softness. We're also investing part of the CapEx that we mentioned in automation, right? So, there's a lot of automation coming on board that's going to continue to unlock gross profit above the line.

So, some mitigating certainly – obviously offsetting things there that will improve as the year goes on, but really it's a vertical mix story and our geographic diversity of footprint that allows us to do that. But I'll let Matt answer the second part.

[Matt Darin, Chief Executive Officer]

And the second part, look in Illinois, out of 185 new licenses into the approximately 20 that have gotten opened so far. So, there's many more that are in various stages. Obviously, the delays from litigation and that's really slowed that down. But I think you're going to continue to see stores open up on an incremental basis as they get built-out and inspected and approved. So, I would expect you're going to see double-digit additions to that list as time goes on. I think similar to New Jersey. You have a lot of people that are currently working on building out locations and finishing doing that prework.

So, I would expect, continue to see that ramp up as we get to the year. And those are many people that we've been working on, discuss in supply and kind of being able to make sure that we can service their shelves as they get open. So, I do anticipate we're going to see quite a bit of new stores opening up in both those markets over the next 12 months.

[Andrew Partheniou, Stifel JMP]

Okay. Thanks. Thanks for that. And thinking about your cost savings overall, understanding the $60 million number is a gross number and thinking about how that could translate to a net number considering that you're still investing in growth markets? You still have some costs that you're taking on from new acquisitions or recent acquisitions? I'm just wondering how should we be thinking about, for example the SG&A line, where we can see cost savings there. Is there potentially any color that you can provide on synergies from acquisitions that you recently closed?

[Matt Darin, Chief Executive Officer]

Yes. I mean, Andrew, again, on the SG&A line, you should see the improvement that's already happened in Q1 and that's going to continue to build. I mean, we levered our SG&A by about 110 basis points improved it over the fourth quarter sequentially. So, you can see it start to flow through. I'm sorry, year-over-year not sequentially, I apologize, year-over-year, but you can see it starting to flow through already and that's going to continue to build.

Obviously, we didn't have the full impact of that in the first quarter as some of the cuts that we undertook really was towards the end of January beginning February. And so, you're going to see a full quarter benefit in Q2 and on. So, we expect to continue to improve on those.

[Andrew Partheniou, Stifel JMP]

Thanks for that. I'll get back in the queue.

[Matt Darin, Chief Executive Officer]

Thanks, Andrew.

[Operator]

[Operator Instructions] Our next question comes from Eric Des Lauriers from Craig-Hallum Capital Group. Please go ahead with your question.

[Eric Des Lauriers, Craig-Hallum Capital Group]

Great. Thank you for taking my questions. I'll try another question on the margins first. Just as we think about EBITDA margins, expanding throughout the year and ending the year at that mid-20s. Just wondering if there's any specific markets to call out that that might be driving the bulk of that margin expansion throughout the year? Appreciate the color that you've given on some of the, you know, more granular projects that you're working on and whatnot and some of the other drivers, but if we could sort of narrow it down to the specific markets driving that, that'd be helpful. Thanks.

[Matt Darin, Chief Executive Officer]

Yes, look, I think it runs the gamut of a – especially, kind of what we call our Tier 1 markets where as we continue to leverage our ability to showcase our own products in our stores, markets like Arizona, where we have 16 high performing locations and a lot of opportunity to continue to increased vertical mix, markets like Illinois where we've made a lot of progress. And as I mentioned on the call, we're really at that 40% regulatory limit in our locations there.

Pennsylvania where we're really kind of at our highest vertical mix that we've ever been and continued opportunities to do that throughout the 18 locations. So, those are three examples of markets where as we continue to focus on that piece along with identifying operating efficiencies. I mean, those are the markets that we are most investing in automation where we've really centralized operations and have found more cost savings and with more to come. And that we're really driving a lot of margin expansion.

[Eric Des Lauriers, Craig-Hallum Capital Group]

All right. That's very helpful. I appreciate that. And the next one from me, so as you're implementing the ERP system, I guess, one, when do you expect that to be, sort of completed here. And then as you, sort of, you know, utilize that to help plan inventory and whatnot, just wondering how your expecting your mix of, you know, premium versus value products to trend throughout the rest of the year? Thank you.

[Matt Darin, Chief Executive Officer]

The ERP projects is ongoing. We're continuing to roll that out really in phases. As we mentioned, it's the first ERP that's live with each of the seed to sale systems. So, a lot of work has gone into and continues to go into to that piece. So, we're continuing to roll that out here. It's going to be continue over the next three quarters, especially and we're phasing that out, kind of in a few markets at a time. So, looking as we get into the end of the year to have that implemented.

On the premium versus value, look I think we're hitting both ends of the segment. I think we're seeing a couple of different trends. First of all, there continues to be a huge focus on the value segment. People continuing to trade down and looking for value offerings and that's why we're and really positive results with the fine brand that we've launched and continue to launch in a number of different states and select essentials, which is our more value oriented vape offering, which has been one of our most successful products in our portfolio.

So, continued attention on the value offering, which we're seeing consumers want to continue to attract to those, but on the other side, we are also seeing strong demand on the premium side. The premium consumer is willing to spend a premium price for a high quality product. And as we continue to roll-out grassroots, in a number of different markets as we're focused on products like our Live Rosin vape products, you know, we're seeing continued opportunity to expand into those and that premium consumer that is willing to pay, kind of a very strong price as long as the quality is there. So, I think both are opportunities on each ends that the barbell for us to continue to build-on.

[Eric Des Lauriers, Craig-Hallum Capital Group]

Alright. Thank you very much.

[Operator]

And our next question comes from Mike Regan from – actually, with that, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to management for any closing remarks.

[Boris Jordan, Executive Chairman]

Thank you everybody for listening on the call and we look forward to speaking to you at the end of the second quarter.

[Operator]

Ladies and gentlemen with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.