Cresco Labs Inc.

Good afternoon, and welcome to Cresco Labs' fourth quarter 2019 earnings conference call. We look forward to speaking with you today and discussing the great progress we have made as a company.

I am joined on the call today by our Chief Executive Officer and Co-Founder, Charlie Bachtell; our Chief Commercial Officer, Greg Butler; and our Chief Financial Officer, Ken Amann. Prior to this call, we issued our fourth quarter 2019 earnings press release for the three and 12 months ended December 31st, 2019.

This document has been filed with SEDAR and is available on our Investor Relations' website at investors.crescolabs.com. We plan to file our corresponding audited annual consolidated financial statements on SEDAR by April 29th, 2020.

Before we begin our remarks, I'd like to remind everyone that certain statements made on today's call may contain forward-looking information within the meaning of applicable Canadian securities legislation, as well as within the meaning of the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Such forward-looking statements may include estimates, projections, goals, forecasts or assumptions, which are based on current expectations and are not representative of historical facts or information.

Such forward-looking statements represent the company's beliefs regarding future events, plans or objectives, which are inherently uncertain and are subject to a number of risks and uncertainties that may cause our actual results or performance to differ materially from such forward-looking statements, including economic conditions and changes in applicable regulations. Additional information about material factors and assumptions forming the basis of our forward-looking statements and risk factors can be found under Risk Factors in Cresco's public filings available at www.sedar.com.

Cresco does not undertake any duty to publicly announce the result of any revisions to any of its forward-looking statements or to update or supplement any information provided on today's call. In addition, during today's conference call, Cresco will refer to some pro forma and non-IFRS financial measures such as pro forma revenue, adjusted EBITDA and operational gross profit, which do not have any standardized meaning prescribed by IFRS.

We believe these non-IFRS financial measures assist management and investors in understanding and analyzing our business trends and performance. Please refer to our earnings press release for the calculation of these measures and a reconciliation to the most directly comparable measures calculated and presented in accordance with IFRS.

These pro forma and non-IFRS financial measures should not be considered superior to, as a substitute for or as an alternative to, and should only be considered in conjunction with the IFRS financial measures presented in our financial statements. Please also note that all financial information on today's call is presented in U.S.

dollars, unless otherwise noted and all interim financial information, including disclosures for any pending acquisition, is unaudited. And with that, I will now turn the call over to our CEO, Charlie Bachtell.

Charlie, please go ahead.

Thank you, Aaron, and thank you, everyone, for joining us this afternoon. On the call today, we'll discuss our financial performance and provide some operational highlights from the quarter and full year.

Before getting into that, I'd like to share our view on the COVID-19 pandemic. While it goes without saying, it's important to acknowledge that this COVID-19 event is one of the most significant health and economic matters in modern times.

While many of the variables associated with a global pandemic cannot be controlled, what we can control as an organization is how we react, how we prepare and how we manage change. With respect to our reaction, in February, Cresco Labs established a task force to monitor the development of the pandemic and to begin outlining and implementing outbreak control measures.

As a stakeholder-focused organization, we are always managing our decisions in coordination with our responsibility to our stakeholders. This includes our employees, our customers, the communities in which we operate, our regulators and state administrations and our shareholders.

Our number one responsibility during this challenging time is the health and safety of our employees and customers. Cresco has a vision of being the most important company in cannabis.

We embrace challenges, we engage in problem solving and we develop solutions that benefit our stakeholders. With respect to our preparedness, the task force quickly moved to bring in an infectious disease consultant, Dr.

Juliana Grant, to help us understand potential scenarios and best practices. With further guidance from the CDC, the World Health Organization and state governments, we developed our plans.

Our approach included dividing our organization into 3 compartments: corporate centers, production facilities and retail stores, and developing action plans specifically designed to address the needs of employees and operational requirements of each business unit. For corporate centers, teleworking procedures and communication schedules were quickly implemented to allow our employees at headquarters to work remotely for as long as needed.

At -- cultivation and production facilities, in addition to increasing all protective and sanitation procedures, we implemented pod systems, a team-based approach to shift scheduling to accommodate social distancing, redundancies and disciplines and insulation in case of illness. We prioritized core functions and cross-train employees to ensure that we have the depth of capabilities at every facility.

Utilizing our preparedness for Illinois ramp up, our scale and corresponding bargaining power, we proactively shored up our supply chain, securing inputs, hardware, packaging and the like. At our retail facilities, unique to any other department because we have employees that directly interact with customers and patients, for these employees, we also enhance safety and sanitation practices.

But when it comes to consumer interactions, implementing social distancing is a greater challenge. In order to eliminate the lines and grouping of people, we shifted to an online ordering process, curbside pickup and home delivery, where permitted.

We implemented designated pickup windows for each order to ensure that we don't have large groups arriving at stores. And we also extended hours to accommodate more customers knowing that the COVID responsible practices can impact throughput.

Aside from operational changes, we've put a proactive emphasis on hiring workers from the restaurant industry and other sectors who have been displaced due to COVID-19. Not only does this help our communities, but it helps to ensure stability in our workforce during a time when illness or employee choice can impact your ability to operate.

In Illinois and Pennsylvania, we successfully delivered plans to our regulators that would enable us to expedite the badging processes, so we can hire employees, train them and have them working faster than ever before. Outside of recruitment, we have put our efforts and resources behind initiatives that speak to our culture and benefit our employees in times of need, such as providing additional essential pay and lunch is delivered at all our dispensaries and facilities to our employees.

This is a way for us to provide a much needed support to local area restaurants, provide a perk for team members and also ensure that employees are safe by minimizing the number of times they need to expose themselves to others throughout the day and return to the facilities. With respect to managing change, I cannot be more proud of our leadership team and every team member in the Cresco family for how they have managed this unprecedented level and pace of change.

Within 48 hours of finalization of the task force phase one plan, we had 100% adoption across our entire multi-state platform. Every team member in the organization was working differently than they had the prior week.

Additionally, dynamic and fluid situations such as this require regular modifications to the initial plans, and our teams continue to manage this incredibly well. Since the initial outbreak, we have been working side-by-side with state and local regulators, proactively presenting community leaders with solutions for a safe and uninterrupted access of cannabis for customers.

We presented the program to enact curbside pickup to the Illinois state government as one way to eliminate gatherings and to ensure social distancing. This is why Cresco puts such a priority on engagement with regulators.

Initiatives like these have been wins and created tremendous value for all stakeholders. It was one of the key elements that allowed us to earn essential business status and stay operational in Illinois and all of our other states.

For customers and employees, it's a convenient, safe way of shopping and provides them access to products they rely on. For Cresco, it moves five to 10 minutes of patient consultation time or customer education from in-store to online, increasing our throughput at the point-of-sale when most other COVID responsible modifications slow throughput.

While we very much look forward to return to normal, these obstacles have required us to quickly adapt and operationalize unique services and product delivery strategies that will continue to be an essential part of how we serve customers in the future. As we transition the company from the entrepreneurial growth phase to the next stage, we're focused on consistent execution at scale, building top-tier management and an operational foundation that can support our core objectives.

As part of this strategy, we've specifically targeted and recruited professionals that come with proven track records of rolling up their sleeves and driving meaningful change and profitable growth within companies that we see Cresco emulating at a steady state. I'm very proud to say that the team of leaders we've assembled to drive this next chapter of the Cresco story is the same team that's been invaluable during this time of uncertainty.

Looking at the companies who have survived economic downturns in the past and have thrived in the aftermath, they were the organizations that had strong cultures. We're able to see the opportunities and the challenges and respond the fastest.

Our leadership team has developed a comprehensive operational plan that accounts for short, medium and long-term impacts from COVID. These plans account for the worst, base and best case impacts on the industry and cover all aspects of our organization.

The way we've reacted to the challenge, prepared for what's next and managed change have put Cresco in a strong position to emerge from the COVID crisis as an even more robust, resilient and profitable operator, with a team that has now successfully faced a once in a generational global event. Turning to our financial results.

Cresco posted a strong fourth quarter and record year, both financially and operationally. Fourth quarter revenue was $41.4 million, representing a 14% sequential increase from Q3, with another quarter of positive adjusted EBITDA at $2.9 million.

On a full year basis, we generated $128.5 million in consolidated revenue, representing a nearly 200% increase from 2018, and our fourth year of tripling our consolidated revenue as a company. Our growth in 2019 was substantially driven by our largest two markets, Illinois and Pennsylvania, demonstrating the value of going deep and focusing on wholesale distribution in branded products.

The results show our ability to gain market-leading positions in multiple states. We are set to drive years of growth, as we repeat this accomplishment in the other states we've entered and gained a foothold.

On our earnings call last May, we defined our plan for 2019, which included a focus on gaining access to the most important markets in the U. S., expanding and enhancing operations in our core markets, strengthening our capital position in a non-dilutive fashion and defining a path to profitability and ability to self-fund our growth.

Since the beginning of 2019, we launched production in Ohio; we closed three transactions, which gained us a foothold in some of the most strategic markets in the U.S., including California, New York and Massachusetts. We've almost doubled our cultivation square footage across the platform.

We've increased the number of doors where our products are sold, already reaching 722 unique dispensaries so far in 2020. And we launched our own branded retail experience, Sunnyside.

We raised over $200 million in gross non-dilutive capital through five sale-leaseback transactions and one senior secured term loan. And to top it off, we achieved our second full year of positive adjusted EBITDA.

2019 was an incredibly productive year, especially considering its challenges, but there is still further to go. For 2020, we're focused on expanding our market-leading positions in Illinois and Pennsylvania, integrating the Origin House transaction and turning California into a center of profitable growth, building the foundation in other states to scale and transition from adjusted EBITDA positive to cash flow positive.

We're off to a terrific start in Q1 2020, and the investments that we have made in 2019 have started to pay dividends. We're pleased to announce that in Q1 of 2020, we've generated approximately $66.5 million in revenue, an increase of over 61% from Q4.

In 2020, having exposure to the strongest states in the U.S. cannabis will continue to be key.

In its first three months, Illinois generated $188 million between adult-use and medical sales, a run rate of $753 million for the year. This market is currently only limited by supply and is projected to mature to a $2 billion to $4 billion market.

As the largest player in Illinois, with three of only 21 cultivation licenses, we continue to responsibly allocate capital into this market and take the strategic steps required to not only maintain our share, but to grow it over time. Earlier this month, we wrapped up construction on the expansion of our Lincoln and Kankakee facilities, bringing our total capacity in the state to approximately 215,000 square feet of cultivation space.

We anticipate harvest from the new rooms will continue on a rolling basis until mid Q3. The Illinois market continues to be significantly supply-constrained and will likely remain that way for some time with an abundance of untapped demand.

In Pennsylvania, a state where we are also the market share leader, we continue to be impressed by the growth of this medical market. According to BDS data, the number of medical patients in the program grew at a rate of 2,000 per week in 2019, with demand still significantly outpacing supply.

I'm pleased to report construction has completed on the cultivation expansion of our Brookville facility, and we expect all new rooms to be harvesting in mid Q3. The team has done an incredible job managing the three substantial expansions across Illinois and Pennsylvania simultaneously.

These three projects secure our next leg of our organic growth and significantly de-risk our company in a time of such uncertainty. In light of the COVID-19 pandemic, I cannot overstate the importance of having these expansions completed.

Earlier this year, we achieved a major milestone and closed the acquisition of the Origin House transaction. And in doing so, completed the first U.S.

cannabis transaction subject to DoJ HSR second review. After a thorough HSR process, a restructuring of the deal terms and the better part of the year's work, we successfully closed the acquisition an incredible testament to both teams and our combined ability to execute.

Cresco is now in a position to accelerate its entry into the largest legal cannabis market in the world. In February, we closed our acquisition of Hope Heal Health in Massachusetts.

With this transaction, we're stepping into a fully operational, vertically integrated business. We look forward to building out our wholesale channel and growing our market share in Massachusetts as we've done successfully in other states.

Our responsibility has always been to allocate capital efficiently and to make prudent decisions that will enable us not only to succeed, but to generate the highest returns for shareholders. In a press release this morning, we announced that we made the strategic decision to terminate our agreement to acquire the Tryke Companies.

Given the decline in capital markets since we signed the agreement, the resulting increase in the cost of the transaction and the variables induced by COVID, we've decided to reallocate the capital that we had set aside here. We have a strong relationship with the Tryke team and think highly of both what they've built in the Nevada and Arizona markets.

We feel the resources previously reserved for the Tryke acquisition now provide us with the ability to pursue organic growth opportunities and to ensure we have the financial strength and flexibility to react quickly to potential new opportunities and/or challenges related to COVID. Our work throughout 2019 has laid the foundation.

We have a strong balance sheet, a deep and experienced management team, a leading position in two states and a portfolio of organic growth opportunities. As we execute on our stated plan in 2020, we going deeper in our core states and focusing on brands and wholesale, we are set to increase our profitability and position ourselves to self-fund years of growth as more of the U.S.

adopts legalization. To provide shareholders with a deeper dive into our strategy and the depth of our management team, in a moment, I'm going to turn the call over to Greg Butler, our Chief Commercial Officer.

To ensure Cresco's success in 2020 and beyond, our commercial strategy has evolved. Greg is leading our team to deliver new product offerings, execute on a multiyear innovation pipeline, manage our Sunnyside retail strategy and help us continue leading the evolution of this industry.

Greg has had an accomplished career in CPG brand building, wellness retail and strategic corporate planning. He has an impeccable reputation for driving profitable growth at some of the world's most iconic companies.

We're grateful to have Greg joining us. And with that, I'll turn it over to Greg.

Thank you, Charlie. It's a pleasure to speak with all of you today.

As you know, Cresco Labs has differentiated itself by becoming the leading operator focus on the middle 2 verticals of the value chain: Branded products and wholesale distribution. We continue to believe this is where the most value will be derived in the long term, and we're allocating to ensure that we are successful in these two areas.

Our commercial strategy is designed to fuel our top-line growth and continue driving more operating leverage as we scale. Our teams are focused on resource planning, so we remain nimble and capitalize on opportunities within a difficult industry to predict.

And we're focused on demand planning; use more data from our business and markets to improve accuracy decision-making. During today's call, I'll provide you an update on the status of our wholesale brands, which includes our integration of the Origin House California platform, Continuum, and also an update on our own retail business, Sunnyside.

Now our goal at Cresco Labs is to build the most iconic brands in cannabis. And we follow a simple guiding principle to deliver growth: Brands that are easier to buy by more people are bought more often.

And similar to any consumer good, brands that uniquely solve a consumer need better than others are easier to buy. And that's why our portfolio strategy is rooted in occasion-based segmentation that helps us identify the varied occasions that exist in the U.S.

cannabis market, who consumers are, what they need and what needs are not being addressed by existing brands. Ultimately, this helps us develop distinctive brand propositions that enable us to reach and delight more consumers.

An example of this includes liquid live resin under our Cresco brand, which has become one of the largest liquid live brands in the U. S.

And our Chef-led, precisely dosed edibles brand, Mindy's, from James Beard Award-winning chef, Mindy Segal, which is a dominant market share of the edible segment within our existing core markets and is growing quickly across newly launched states like California and Massachusetts. We are also focused on addressing price needs by offering products that play against pricing points, not just within premium segments where we already have a strong position, but also playing across a good, better, best pricing offering.

For example, we recently launched a new brand called high supply, which competes in the entry price goods segment of flower and vapes. And it's already becoming one of the fastest-growing brands in our portfolio, delivering incremental volume and margin.

So this strategy is working for us, and we will continue to invest behind it. And as more state data becomes available, we'll continue to share our success against key metrics used within the CPG industry, such as volume growth, share performance and price point penetration.

Now in addition to brands that are easy to buy, access to more consumers and patients in key markets is critical to our growth. And so when we think about our footprint and analyze where we can generate high levels of return, it must fit into one of two categories.

One, it's a state that has a limited license structure and the market is expected to grow. These are states like Illinois and Pennsylvania, where we already have a strong position, access to 100% of dispensary doors within the state and we can allocate resources to maintain and grow our market share and, therefore, providing a faster return.

Or two, it's a state with an already established program with ample opportunity to reach a large number of consumers and access a high percentage of doors in the state. These are states like California and Massachusetts.

Our job in these markets is to introduce our brands within key accounts where we can invest to drive trial, brand awareness and build strong dispenser relationships, backed by our growing corporate reputation and capture market share. Now the combination of Cresco's leading brands and Origin House's leading distribution platform in California accomplishes just that.

Since closing the Origin House transaction, we've been focused on capturing cost synergies by combining our organizations, driving increased revenue growth across the existing Continuum platform and optimizing our operations within the state, across our facilities at FloraCal, Carpinteria and Mendota. The teams have come together and are executing on our plan for cost reduction through back office synergies, restructuring our go-to-market approach and rightsizing the portfolio of partner brands on the platform to focus on scale and profitability.

To date, we have already realized $7 million annualized synergies alone. And we will continue to provide synergy updates for Origin House throughout this year.

But let me reinforce that California remains an incredibly attractive market for us. It's a market approaching $4 billion, driven by a diminishing illicit market, and we are very encouraged with the actions being taken by the California state government to increase regulatory controls.

We have a tremendous opportunity ahead of us in California. And so far, we are encouraged by our Q1 2020 results as we have begun to sell more of our brands across the Continuum platform.

Not only are our brands being accepted in the leading dispensaries across the state, but also gaining strong share of shelf and have been asked to complete hundreds of in-store demos this year leading up to the COVID complications. Now, finally, let me touch on our own retail brand, Sunnyside.

While we remain focused on our wholesale business, owned retail with limited license states offer strong economics over the near-term. For example, in Q1 of 2020, our five Illinois stores generated an average revenue per square foot of about $4,800.

And in addition to strong financials, owned retail provides incredible consumer data within an industry where category and consumer insights are not easily available. And as we continue to scale Sunnyside, we're focused after its success on building meaningful customer experiences that will deliver strong financial results and continue to normalize and professionalize the industry to recruit customers to our stores.

And building meaningful customer experiences starts with our store experience. This year, we harmonized our stores into a standard scalable model and enhanced our in-store, out-of-store experience.

Through online ordering, extended hours, scheduling software, and increased use of automation, we're allowing our customers to manage their own experience within Sunnyside, while increasing our overall throughput at our stores. We've also established a new commercial planning function and assortment strategy to ensure we have the optimal inventory on hand to maximize customer baskets.

And this includes our own brands, but it also includes local and MSO suppliers, enabling us to maximize both revenue and gross margin within each store. Building trust with customers is at the heart of Sunnyside and we are focused on solidifying these relationships through our digital platforms to provide personalized experiences and loyalty to our stores.

For example, customers in Illinois that often opt into our e-mail or text platform have a 30% larger baskets than those that don't. So, continuing to drive digital relationships is critical for us.

Finally, our real estate strategy is designed to build our stores in the best locations. As we add new stores, we look for locations that carry outsized cultural and brand building potential.

Our River North location and planned Rig Reville location are perfect examples of this as they are in the heart of Downtown, Chicago neighborhoods. River North is home to hotels, restaurants in a variety of night clubs in the area touches Chicago's premier commercial districts and a destination for the city's 55 million annual visitors.

Rig Reville is in the sport and entertainment hub of Chicago, which is a tremendous location too. The strong economics and customer insights are reasons why owned retail is a part of our growth strategy.

We believe that when you look at this industry in 10 years, the winners with the companies that have developed strong brand equities and can get products on shelves consistently. Brands that are easier to buy by more people are bought more often.

This principle is at the heart of everything we do and will continue to drive our commercial strategy and financial growth. I'm excited to apply my experience to this industry and firmly believe in our long-term growth strategy.

Thanks everyone. Please stay safe and I will pass the call back to Ken Amann, our CFO, to provide highlights from our financial results and discuss our capital agenda.

Thank you, Greg and thanks to all of you for taking time to join us on today's call. Our results continue to provide strong validation of our leadership position as one of the top-performing multistate operators, our relevance to regulators, and our ability to manage our business in an unprecedented environment, all to deliver significant value to our patients and customers, our employees and our shareholders.

Let me begin by providing an update on the consumer trends we see in light of COVID-19. And afterwards, I'll review our financial highlights, including an early look at our revenue in the first quarter of 2020.

Please note, all numbers are denominated in U.S. dollars.

Since the outbreak of COVID-19 began, what we've seen is, after initial spike indicative of pantry loading, followed by a correction as we transition to online ordering, sales have returned to a consistent pattern of growth. It is clear to us that consumers prioritize cannabis products as a staple in their household budget higher than other discretionary goods.

This is a strong validation for the resilience of our industry. Comparing our Illinois weekly sales data just before and after the COVID-19 outbreak began, average number of tickets declined by 15%, and the average ticket size increased by 13% over the same period.

Of course, these trends have ranged greatly state-to-state and in states with more strict shelter and place measures, the impacts were amplified. In the case of delivery-only market, it often takes more time to fulfill one order than 10 transactions happening in-store, and fewer customers can shop at a dispensary at one-time is six feet of distance is needed between them.

It is hard to determine how COVID-19 will affect our full year performance in 2020. Accordingly, our team has modeled a variety of scenarios, and we remain confident in Cresco's position and ability to be nimble in our response to considered outcomes.

We proudly have strength in our balance sheet, and the large portion of CapEx investments are behind us. Turning to our results.

In the fourth quarter of 2019, we generated $41.4 million of revenue, up 144% compared to the same period of the prior year, and 14% sequentially from the third quarter. We generated 85% of our revenue in our three core states of Illinois, Pennsylvania and California.

We believe these three markets continue to represent the greatest near-term growth opportunities for Cresco, and we are allocating our resources accordingly. Our revenue mix in the fourth quarter held steady at 64% wholesale, 36% retail.

Once again, this solidifies our position as the foremost cannabis operator, focused on the wholesale distribution of branded products. For our five retail locations in Illinois that have been opened for at least a year, we are pleased to report same-store sales growth of 55% for the period ending in December.

During the fourth quarter, we closed on the acquisition of Valley Agriceuticals, and we gained operational control of Hope Heal Health, beginning our consolidation of revenue for both in Q4 in advance of the closing of the HHH transaction in February 2020. On a pro forma basis, revenue for the fourth quarter of 2019 increased incrementally to $56 million, which includes Origin House and certain minority investments.

We note the growth in organic revenue outpaced pro forma in Q4, but as Charlie and Greg both illustrated, we remain confident in the long-term growth outlook for these assets that were added to our portfolio. With the termination of the Tryke acquisition, Cresco effectively has no pending M&A transactions.

The original consideration included approximately $55 million of cash, as well as a substantial equity component. These resources that were once earmarked for new assets in Nevada and Arizona can now be put back into supporting our powerful capital base and can be applied to the organic growth of our business and new growth opportunities.

Having closed Valley Ag, HHH and Origin House within a span of just four months, we've proven our ability to close on strategic M&A transactions. We will continue to evaluate opportunities that support our strategy, have high-return profiles in strategic markets and help Cresco grow profitably.

The fourth quarter momentum that we experienced has continued into 2020. Combined with the entrance of new recreational customers in Illinois, we have delivered approximately $66.5 million of revenue in the first quarter of the year, up 61% from Q4 2019 and 216% from Q1 2019.

As a reminder, our business in California during Q4 included selling Cresco branded products into Origin House's distribution platform, so the consolidation of Origin House in Q1 is additive mostly to the gross profit line. We are pleased with our performance in the first quarter.

And despite the impact of COVID-19 has had so far, we anticipate continued growth, both on our top and bottom line for the remainder of the year. As Charlie mentioned, we now have completed our ambitious construction projects at our Lincoln, Illinois and Brookfield, Pennsylvania facilities.

We will realize the effects of these expansions starting in Q2, and ramping up as we harvest new rooms through mid Q3, which will provide for substantial revenue and increase in market share in both states. Operational gross profit in the fourth quarter of 2019, excluding the impact of biological assets, was $21.2 million or 51% of revenue, compared to 47% of revenue in the third quarter and 45% of revenue in Q4, 2018.

This improvement was in line with our internal forecast and driven by our increased production capabilities and our continued efforts to drive operating leverage. To give a few examples, in Brookville, we've invested in new extraction platforms that improved extraction yields by 20% and increased extraction capacity by 89%.

In Joliet, new edibles equipment increased throughput by 50% in Q4, while at the same time, reducing the number of shifts required. We anticipate some pairing of margins in the first half of 2020, as we work to integrate Origin House, but expect to return to continued margin improvement as we scale and optimize our operations in California.

Fourth quarter SG&A expenses, including non-recurring items and equity compensation, was $20.8 million, or 50.2% of revenue. The increase in SG& A as a percent of revenue, compared to prior quarters, was mainly driven by investments in infrastructure, technology and key hires ahead of the adult-use launch in Illinois.

We've also made thoughtful investments in OpEx to support initiatives that better position the company for future growth. We anticipate OpEx to fall as a percentage of revenue over the course of 2020, and especially as we complete the integration of Origin House, and generate significant economies of scale in Illinois and Pennsylvania.

Adjusted EBITDA, excluding the net impact of biological assets for the fourth quarter, was $2.9 million compared to minus $300,000 for the prior year period. Similar to gross profit, we anticipate improving adjusted EBITDA through 2020 as revenue ramps up and SG&A settles back in line as a percentage of revenue.

Turning to the balance sheet. We ended the fourth quarter with $49.1 million in cash, compared to $73.7 million at the end of the third quarter 2019.

The increase in cash utilization is attributed to the expansion of operations, mainly at our facilities in Illinois and Pennsylvania, as well as the acquisition of Valley Ag. CapEx was $41.1 million in Q4, and based on our forecast, CapEx will be elevated again in Q1, then decline for the remainder of 2020 as most of our expansion efforts are behind us.

Moving forward, we expect facility expansion will primarily be funded with tenant improvement allowances and for cash flows from operations. Switching over to our financing activities, we've been able to successfully monetize our real estate assets to non-dilutive sources of capital through multiple sale-leaseback transactions and are evaluating opportunities to do so for other locations.

To-date, we have announced the closing of agreements to sell our Joliet and Kankakee, Illinois properties for approximately $46.3 million; closing of the agreement to sell our properties in Yellow Springs, Ohio for approximately $10.5 million; the closing of agreement to sell our Lincoln, Illinois cultivation facility for $50 million; and most recently, the closing of the agreement to sell our Marshall, Michigan facility for $16 million. In February, we closed on a non-brokered senior secured term loan agreement in an aggregate amount to $100 million with a neutral option to increase the size of the facility to $200 million.

And another example of our proven ability to execute, we diversified our funding sources, improved our cost of capital in a non-dilutive manner and have given ourselves the flexibility in otherwise challenged capital environment. In the process, we added new shareholders who invested in the long-term success of the company.

The proceeds from the loan have been used to fund continued expansion of operations in key markets, and the closing and integration costs associated with acquisitions. A major focus of our third quarter earnings call was devoted to our capital agenda, and I would like to highlight now how we're tracking on our plans.

Since the inception of Cresco, we've been focused on creating a top-tier portfolio of brands and building out our wholesale channel and strategic footprint. In Illinois and Pennsylvania, we believe we've reached that inflection point in both verticals.

We will continue to make incremental investments in those markets to continue to protect and grow our leading positions. In California and Massachusetts, we see large established markets, we can generate a high-return today by investing in our operations and we expect to see operating leverage continue as we kick in scale.

In addition, we have an abundance of long-term growth opportunities in other states, where we plan to go deeper once our core markets have ramped. Cresco is in a better position today than we've ever seen before.

Our balance sheet is strong. We've closed on all outstanding acquisitions.

Our major expansion projects are either completed or being funded with sale-leaseback transactions. And as our Illinois and Pennsylvania facilities increased our supply and our California operations start to gain momentum, Cresco will be able to generate significant positive cash flow to take advantage of high-return opportunities available to expand and continue to be the most important cannabis company in the U.S..

Thank you for your time today. I will now pass the call back to Charlie for final comments.

Thanks, Ken. At a time when all of us are committed to social distancing and ensuring the safety of our families and communities, communication is of the highest importance.

In an effort to increase our communication with you; our investors, the Cresco team is launching two new initiatives. The first is a series of public teach-in sessions.

These teach-ins will be focused on specific areas of our Cresco's operations, led by members of our senior leadership team to provide a deeper hands-on view in our strategy. The second is the launch of an investor newsletter, a monthly communication with some highlights from myself and our leadership team as well as a summary of all corporate updates, so you can follow along with our company's growth.

To wrap up, I know I speak on behalf of the entire team when I say that I'm very excited about the future for Cresco. We're executing on our strategy and positioned perfectly to capitalize on opportunities in 2020.

We consistently demonstrate a unique understanding of where this industry is going, and we have the most reliable and dynamic leadership team as a foundation. Thank you for your time today, and I'll now ask the operator to open the line for questions.

Hi, thanks guys. Good evening.

Just wondering, in terms of your balance sheet, I appreciate the color and the disclosure you guys gave us in the press release. But if I just kind of add up all the numbers there and the $49 million you guys had at the end of the quarter and make an assumption on Hope, in terms of what that cost, would it be fair to say that you guys are at around between $150 million and $175 million in capital at this stage?

Hi, Derek, this is Charlie. Thanks for the question, and I'll pass it to Ken.

Hi, Derek, it's Ken. Overall, our cash position in the quarter, we ended with $49.1 million in cash.

That was down from $73.7 million last quarter. That decrease in cash was attributed to the expansion of our operations, mainly in our facilities in Illinois and Pennsylvania, as well as the cash consideration associated with the acquisition of Valley AG.

I would like to note that CapEx will be elevated again in Q1 and then decline significantly for the remainder of 2020, as most of our expansion efforts are behind us. If you look at the puts and takes, moving forward, then subsequent to the quarter, obviously, Origin House completed their equity financing for roughly $30 million that Cresco closed on our credit facility in the aggregate amount of $100 million, with a mutual option to increase that facility up to $200 million.

And then we closed on two sale-leaseback transactions related to Yellow Springs, Ohio and Marshall, Michigan for a total of nearly $27 million combined. And then that's partially offset with the CapEx usage in Q1 and cash considerations for the close of HHH.

So if you work through that, that should certainly get you in the range. I mean, overall, especially with the actions that we announced earlier today regarding Tryke, that puts our balance sheet in a really strong position as we have no cash requirements related to pending acquisitions.

Again, our major expansion projects are behind us, so they're being funded with sale-leaseback transactions. And again, with the significant increase in production capacity that we have now created in Illinois and Pennsylvania, nearly a 5x increase plus momentum in our California operations, this puts Cresco in a really positive position to generate significant cash flow in the back half of the year.

Hi. Good evening.

Thanks for all the color. I hope everyone is safe and healthy.

My one question is a two-parter, please. In terms of the $66 million in change that you generated in the first quarter, can you offer any detail on how that phased over the course of the quarter?

Just trying to understand how big of a bump you saw in March. And then also if you could offer some color on the mix by state?

Thanks.

Hi, Vivien, it's Charlie. Thanks for the question.

I think we saw pretty strong revenue growth through the quarter, again, with the COVID coming in about halfway through March. It definitely had its impact in those first couple of weeks of the COVID event, but strong growth really building through the quarter.

And Ken, if you want to add a little bit more color on that.

Yes. Hi, Vivien, this is Ken.

As it relates to the comparison of our Q4 revenue to our Q1 pro forma revenue, it's important to note that, that 19% sequential increase is on the exact same asset base with no meaningful cultivation square footage come online in Q1 and no additional dispensaries. So, that was primarily attributed to higher retail sales in Illinois.

Obviously, with that, with the completion of the expansions we've done in Illinois and Pennsylvania, again, we'll see more meaningful growth in the back half of the year, but that 19% growth was on the exact same asset base.

That's helpful. Thanks.

Thanks Vivien.

Thank you and hello everyone. I want to follow-up on the question from Vivien also.

So, consensus had about $80 million for the first quarter, you are doing 66%. I understand these are hard times.

And you've just said, the capacity hasn't come in. So, I guess I have two questions.

Was anything down in the first quarter in pro forma terms, for example, Origin House? And given that -- the second part of your question is that given the expansion is really kicking in, in the second half, I guess, we should not assume much sequential growth in 2Q because you still have the same capacity pretty much.

If you can give some color on that, that would be helpful. Thank you.

Thanks Pablo. It's Charlie.

So, to sort of take the first part of the question, as it relates to the expectations, we had, as Ken had mentioned, the same asset base from pro forma Q4 into Q1 with nice growth over that same asset base. And we are seeing some -- the improvements in revenue being driven by additional capacity within the markets that we're in came on.

So, like in Q1, there was additional capacity that came into the marketplace from some of our peers and other operators, hence, the growth in retail sales with us still having a similar to same footprint. You will start to -- as we have released previously, you will start to see some of that additional capacity come on from our expansions in Illinois and PA as we get into -- mainly into May.

So, we'll see some expansion there, but definitely ramping up as we get into Q3. Ken, some additional color?

Yes. Hi Pablo, this is Ken.

I would say that in Q1, we certainly benefited from the closure of Valley Ag acquisition and the consolidation of Hope Heal Health. Again, without that meaningful production capacity coming online, we were still able to achieve double-digit revenue growth in our core states.

I will say, though, that, that growth was somewhat offset by California as we took actions to exit unprofitable third-party brands off the Continuum platform. But we're still on the early period of that growth cycle, working on implementing our plan and our operating model, and we expect continued growth as we continue to push the Cresco branded products through the Origin House's distribution platform.

And we've had success in that recently as the Cresco branded products are representing now about two and a half times the volume going through that distribution network than they were just 90 days ago.

Thank you. Could you give us just a little more sense of how the trajectory for margins and cash flow is likely to play out over the course of the year?

And you talked about second half cash flow positive, but would it be sort of a steady build to that or maybe a little more of a spike? How should we think about modeling some of those pieces?

Hi, Michael, I'll give that to Ken.

Hi Michael, it's Ken. As you saw in the quarter, we did improve gross profit margins by nearly 400 basis points.

That was largely the result of our efforts to drive operational efficiencies in our cost base quarter-over-quarter. And while we expect the gross profit margin leverage as we ramp up our cultivation capabilities in Illinois and Pennsylvania, we do anticipate some pairing of margins during the first half of 2020 as we work to integrate the Origin House platform, but expect to return just 50% plus gross profit margins.

We optimize our operations in California. Longer term margins, we expect them to be consistent with the CPG category, which generally comes in around 55%.

In terms of the build, as we announced recently with the completion of our expansion efforts in Illinois, we'll start seeing some of that capacity coming online towards the back half of Q2. And then in Q3, where we hit full production capabilities, so it is certainly going to, from a steady state perspective, we get there in the third quarter.

And so that expansion and that lift is quite a big operating leverage boost that we should be careful not to get ahead of and that it's, say, on the EBITDA margin level, sort of, similar to 4Q a little until roughly 3Q this year?

Yes. As you move throughout 2020, you will certainly see -- as you get through some of the lumpiness in Q1 associated with Origin House, once we've optimized that and completed some of our cost savings initiatives there, that will certainly then flow through on to our EBITDA line.

But certainly, you're talking about a 5x increase in our production capabilities that are coming online. And largely, most of our fixed costs now to drive that top line growth, we've already made those investments.

So we should see significant leverage on the EBITDA line in the back half of the year.

Hey, good afternoon guys. Just on the Origin House integration, the $7 million of synergies that you pointed to.

Just, kind of, curious how far along are you in the overall integration efforts? And how that impacted, if at all, by COVID and the ability to kind of get that margin recovery in the back half of the year?

Thanks, Jesse. I'm going to have Greg take that.

Hi, Jessie. I think the question you're asking specifically is around COVID impacting our ability to achieve synergies.

As we said in previous conversations, in Q1, and back half of Q4 of last year, our focus was back office synergies. So that was about reducing some headcount, that was about reducing some of the costs that we have in our infrastructure and making some changes to our go-to-market approach in the state.

All of that really is in our control. It isn't impacted by COVID.

As we now look to the future market of moving our brands into the market, we are encouraged by what we're seeing. We've started to move our brands onto the platform.

We're starting to get distribution within key accounts across the state. And we're building our revenues against the existing Cresco Labs brand as we now move into Q2.

Good afternoon. Thanks for the question.

Real quick now, you've moved out of Arizona, Nevada. Are there other states, California in the West, are there other states that you guys look to put your hat on outside of Illinois, Pennsylvania and California that we can expect to ramp up a little bit here in the second half too for 2020?

Yes. Thanks for the question.

This is Charlie. I think we are taking a very appropriately measured approach to what the rest of the year looks like, especially from an expansion standpoint.

We're dealing with an unprecedented scenario here that just is a variable that can't truly be properly anticipated as to what the greater impact will be. So first and foremost, it is about making sure that we execute on these phenomenal markets that are already under the umbrella and very, very strategically use the capital that we have and where we invest it.

We do see us, again, permitting; we will be looking to go deeper into the markets that we're already in, which would include Arizona. But we'll be cautiously observing opportunities that come about over the next three, six, nine, 12 months that are really associated with the difficulties that a lot of operators in this space are going to -- we're already having and are only to be magnified by the COVID impact.

So we will continue focusing on that, executing everything that's underneath the umbrella already, looking at strategic opportunities to expand in the markets that we're already in and keeping a cautious eye open on potentially very cost-efficient opportunities that can arise over the next six, nine, 12 months.

Hi. Thanks for taking the question.

On the Origin House, I think, you mentioned there was some offset to growth in that you exited unprofitable brands. Curious, if you're completed that action or if there's more to go?

And just in general, can you say, like, will 2020 be a year where Origin House grows versus 2019? Or will it be kind of flat or down directionally?

Thanks for the question. This is Charlie.

As far as the rationalization of the portfolio, we're in a good spot, and we're excited about really the efficiencies and the focus that we have brought to it. The integration has gone very well.

And that's it. It was a tough integration.

I think it's fair to acknowledge that, that was a tough transaction. It's going through that second HSR review is not easy.

Restructuring that deal to make sure that it made sense, it was also not easy. And immediately post closing, we had a lot of work to do to make sure that we brought the teams together and really established the one company culture.

And along with that, then start doing identifying and we're executing, I should say, on the synergies and the rationalization that needed to happen. So happy with where we're at with it.

And, especially, as it relates to the brands, and I know Greg has some more on this, too.

Perfect. Let me just build on that.

And thank you for the question, Glenn. I think your question was specifically, had we finished our refocus of our portfolio in the California market.

The answer to that is, yes, we have. That was the focus as we went through Q4 post-closing and Q1 of this year to make sure that we had the right brands on our portfolio.

Right now, our portfolio, we feel, is in a great position to take on the California market. We have some large brands, some profitable large brands that have the ability to scale.

And now we also have our owned Cresco Labs brands on that portfolio and moving -- and as Ken has mentioned before, that's really important for us because our own brands do come with them a very strong margin position. And so, we feel really encouraged with not only the brands that are now on the platform and how those brands are performing within the state.

Great. Thanks.

Hi, good afternoon and thanks for taking my question. I wanted to get some color with respect to the core markets like Pennsylvania and Illinois, where there's still some anticipated openings at retail.

And you mentioned some details earlier on the call with respect to the size of the cultivation manufacturing capacity in Illinois. With COVID-19, you were able to operate under the essential service designation.

But are you expecting any material hold-ups on potentially opening any new stores or any of that additional capacity beyond the 250,000 square feet? Is it difficult at the municipal level to get an understanding that you are, in fact, essential?

How does that look -- as best as you can provide in sort of the remainder of the year-to-year.

Sure, Graeme. This is Charlie.

Thanks for the question. It really is -- it's such a dynamic situation.

And it definitely is state-by-state and can be even municipality to municipality. As far as Pennsylvania and Illinois, I mentioned it on the call, I can't stress how important it is that we have our substantial cultivation expansions completed -- doing anything that requires any level of approval at this point.

Again, all case specific and geographically specific can be challenging. And we're seeing it.

We're seeing it in certain areas on the retail side. We've got state approval for that dispensary in River North, but we're still waiting for the final city component of it.

And that the regularly scheduled hearing, where that would be addressed, has now been delayed 3 times due to the COVID issue. So you do run into that potential friction.

And I would say, maybe more so municipality-wise than at a state level. But again, we are very happy to have our cultivation expansions completed.

It does give us the platform to see sizable growth throughout the remainder of the year. And with both of those markets still being defined as significantly supply-constrained markets, even based on the number of doors that are currently open and operational, it does position us well.

We're still confident that we'll be able to get the additional retail locations open in both of those markets on a relatively timely basis. But once you get into the municipalities, it can be a little trickier than meeting state approval for something.

Hello everyone. Just looking past Q1 and Q2 of 2020 with CapEx moving to a little bit more normalized levels, just want to get your thoughts on how you're thinking about potentially entering new markets?

Is Arizona and Nevada still markets you would look to come back to on the M&A side? Or is the work being done to expand organically there?

Can you just talk about that dynamic a little bit?

Yes. Thanks for the question.

This is Charlie. Yes, we absolutely like the Arizona and Nevada markets.

And again, we do have an operation in the Arizona market. We are not satisfied with the footprint that we have.

It's a single asset. We want to go deeper in all of our markets.

We're very happy with where we're at with Illinois and Pennsylvania. And of course, we look to continue to actually build upon the market-leading positions we have here.

But that's the goal in every market that we're in. Our sort of strategy and philosophy is pretty simple.

It's that strategic geographic footprint and it's meaningful material positions in every one of those markets. So we'll continue to look at Arizona and Nevada.

And we'll be very selective with how we allocate capital but definitely looking to improve the positions that we have in those markets. Ken, do you have some more color?

Yes. I think it's important to know that just more broadly, as it relates to M&A, I feel like we have plenty of organic growth opportunities, and that is our number one priority.

But in the current environment, it's fully possible that we see good opportunities to acquire attractive assets at reasonable valuations, and we'll continue to evaluate those opportunities on a case-by-case basis. But we only want to consider premium assets from groups that are selling for reasons other than fundamental issues.

I'd say in a short to midterm basis, our bias right now is towards smaller tuck-in acquisitions that improve our position in existing markets.

Thank you and good evening. I'd like to focus just briefly, if we could, again, on Pennsylvania.

Both you and a number of your competitors have recently completed or in the process of completing a major capacity expansions in the state. Could you speak to your outlook on the state?

The competitive intent in the state and how that's changed? And perhaps also your margin profile sort of in year, either absolute or relative and how you expect that to evolve?

Thank you.

Sure. So thanks for the question.

The Pennsylvania market, again, I think it's one of the few markets in the industry, in the country, where you really -- you still don't see the feeling. It is, by definition, supply constrained.

It has ramped up and grown as a medical program. It's on par with the fastest-growing medical programs that the industry has ever seen.

Arguably, I think it's probably the top on a per capita basis. So we continue to just see such strong demand there.

While you mentioned a few of our peers have completed construction projects and expansion projects, I am not sure that maybe one or two have completed any expansion of significance. I think a couple of them have plans to do so.

And as I mentioned earlier in the Q&A, I can't tell you how important it is to already have that expansion completed in this time with the uncertainty. So we're very bullish on the PA market.

You will continue to see us properly and appropriately allocate resources to these markets that have phenomenal return on invested capital, and Pennsylvania is definitely one of them.

Hi, guys. Thanks for taking my question here.

I was wondering if you could speak a little bit to the market development in Illinois in April. If what we had seen in some markets stronger demand due to COVID was being realized or a capacity too constrained there?

And in the context of your advanced production capacity, how do you think that's going to play out for your wholesale market share? Are you going to be able to likely boost that from historical 20% to 25%, maybe into the 30% range, at least in the back half of the year?

Thanks.

Yes thanks Robert and welcome to the Cresco family. We are happy to have you on Board.

I'll answer some of that and then I definitely want Greg to give some of his insights on it. But yes, April has been a, I would say, a month so far of refining the new ways of working, right?

Across the platform, as I mentioned in the call, you have to change the entire way that you operate from all sort of compartments of the org, corporate, production facilities, and at the brick-and-mortar retail dispensaries. And that consumer experience had to be modified as well.

And it's not just good practice and sort of an obligation. It's a requirement.

The state will shut down dispensaries. And there are a couple that have either received notices of this or had temporary issues where they weren't observing COVID responsible practices.

And COVID responsible practices just inherently are going to sort of disrupt the traditional way of bringing consumers into the retail establishment and getting that throughput and the consumer experience has totally changed. So, what I think we've seen so far in April is continuous attention to refining the COVID responsible practices that we implemented and being able to pull on the different levers to make sure that we get the total throughput back to the levels of pre-COVID.

And then we continue to build on it from that. And then I'm going to turn it over to Greg.

But yes, we're definitely -- we still see that even in this environment, in the COVID sort of impacted marketplace in April here, when there is a delivery, when there is new supply, when there is flower that becomes available, you see very high demand those days and consumers figuring out how to get into the stores and buy it. So, Greg, some more detail on that.

Hi, Robert and thanks for the questions. I think to just echo some of the points that Charlie made is that we, in Illinois, we just saw a tremendous performance out of the gates adult-use, I think, from per capita perspective, it's one of the strongest adult-use launches in the country.

And then even during COVID and Charlie talked a little bit about this, demand remains the highest we have ever seen. And what's really driving revenue is responsible surveying of that demand.

And that's ensuring that we have stores that are practicing good social distancing, that we're prioritizing medical patients who are in need of cannabis in their medicine. But to Charlie's point, really what we're seeing from a tickets and baskets perspective in the state is strong tickets and our ability to serve those tickets is restricted by both social distancing and then also, of course, staying open to serve both medical and adult-use customers.

And from a basket perspective, we saw some strong growth of baskets at the very beginning of March as consumers were preordering and stocking up pre-COVID. And as time has continued, those baskets have now leveled off and getting back to a really stable perspective.

And so if you think about it from an Illinois, April for us, looks really strong because we're learning how to service demand effectively through our stores. The demand is there, as Charlie mentioned.

The product is coming in online. And the baskets are there, too.

And so we feel quite confident in our ability to serve April and the months ahead.

Thanks guys for taking my call. You just -- you mentioned just the last question, the last answer was that your ticket size have changed under this COVID environment.

Just wondering, though, if you've seen a difference in product type in terms of more towards edibles where they are available or what you're seeing in terms of product type selling in this current environment? Thanks.

Thanks for the question. The -- again, a dynamic situation, and we have spotted some trends.

As you mentioned, from the basket size, as it relates to product mix, I think we have seen some consolidation in product mix. And I think that's -- again, even I can tell you from the production side adjusting for COVID in the modifications that you have to put in place at a production facility requires that you rationalize even the number of SKUs and the types of SKUs that you are producing.

So there's going to be some inherent consolidation at the retail level too, because the available products that are being produced have also consolidated. Greg's got some more color on this, too.

Hi, Jason, it's Greg, and thanks for the question. Just want to kind of reiterate on the point before.

Baskets, we saw a growth in baskets leading up to COVID as consumers were stocking up. Very consistent with what you're seeing across retail in general.

And since then, those baskets have now stabilized as we've moved through the COVID crisis. I wanted to highlight that one.

The second part of your question, which is how the basket itself has changed, what you are seeing in this market is those consumers were going into our stores are medical consumers. Medical patients continue to show similar purchase behavior trends.

And I would say, more cannabis-aware consumers continue to enter our stores, which means that you are seeing forms like flower, kind of, grow in those baskets. I think as COVID passes and you have more traffic into the stores, you start to see consumers who are purchasing a different product set of products.

But to answer your question right now, from a COVID perspective, our baskets remain pretty strong. And if we were to report on any real changes we're seeing in basket behavior, it's that is more flower has become available.

Flower has grown a bit in basket over the last couple of weeks. But again, we're living in ever changing times, and so that's what we're seeing right now.

So with that, that was the last question. And I just want to thank everybody for joining us on the call today.

This has been a, without question, an interesting start to the year with an interesting dynamic that all of us in the industry are doing our best to manage. Couldn't be more proud of the team in the way that they've approached it.

And we're looking forward to the rest of a successful 2020 here. With that, I want to wish everybody a good evening, and stay safe and healthy.

Thank you for joining us. Bye-bye.