Cannabis Insight | TAX SMARTS? TCNNF (+), Thoughts on CRLBF & MRMD

Trulieve Cannabis Corp. Tax Smarts? Crafting a Brighter Future with Strategic Financial Wisdom For the Greater Good?

TCNNF is not on the position monitor, but I like the CEO's resolve and strength she is showing.  

Recent Revenue and Financial Performance:

3Q23 revenue was $275 million, exceeding guidance and declining 2% sequentially. Net loss: $25 million in Q3. Adjusted EBITDA: $78 million (28%). Gross profit was $143 million or a 52% margin, which improved by 2% to 52%. Adjusted EBITDA: $78 million (28% margin). The 23rd consecutive profitable quarter. Operating cash flow was $93 million; Free cash flow was $87 million. Focusing on customer experience, product quality, access/distribution, and expanding the retail network to 190 dispensaries, including new customer-facing initiatives and data platforms for targeted outreach, all make sense. The Columbia Care acquisition was ill-timed, and shareholders still pay the price. Potential growth from adult-use programs in Florida, Ohio, and Pennsylvania can help. Still, timing matters, with the granddaddy being prepared for adult-use market expansion in the home market of Florida.

Balance Sheet and Tax Strategy:

As of 3Q23, TCNNF cash reserves stood at $200 million. In a strategic move to strengthen its financial position, they have taken proactive steps in reducing debt, including the early redemption of senior notes. More importantly, in a significant development, it recently submitted an amended federal tax return, through which we are seeking a refund of $143 million. This move by Trulieve is strategic and deeply rooted in the intricate landscape of U.S. tax regulations in the complicated cannabis industry. Below, we delve into the critical aspects and strategic thinking behind this decision:

Section 280E of the U.S. Tax Code: This is a critical aspect of the strategy. Section 280E prohibits businesses engaged in the trafficking of controlled substances (including cannabis, which is still federally classified as such) from deducting ordinary business expenses from their gross income. This results in significantly higher taxable income and, consequently, tax liabilities for cannabis companies compared to businesses in other industries.

Challenge to Tax Liability: Trulieve is challenging its tax liability under Section 280E by filing amended returns. This challenge could be based on various legal arguments about the interpretation or applicability 280E to their specific operations or circumstances.

Claiming a Refund: The refund of $143 million represents taxes already paid, which Trulieve believes were overpaid due to the application of Section 280E. If their challenge is successful, it could set a precedent for other cannabis companies facing similar tax burdens.

Strategic Timing: The decision to file these amended returns comes when there is increasing momentum for cannabis legalization and regulatory reform at the federal level. This evolving landscape might influence the outcome of their challenge.

Financial Impact: If successful, the refund would significantly bolster Trulieve's financial position, providing additional capital that could be used for growth, debt reduction, or other corporate purposes.

Broader Implications: A favorable outcome for Trulieve could have broader implications for the cannabis industry, potentially leading to changes in how cannabis businesses are taxed and, more broadly, how they are treated under federal law.

Risk Consideration: Such actions also carry risks. The IRS could deny the claims, which might lead to prolonged legal battles. Additionally, it puts the company in the spotlight regarding federal cannabis laws and tax policies.

Here is the company rationale for the move

Nature of Business Activities: Some cannabis companies argue that not all of their business activities fall under the purview of Section 280E. For instance, they might claim that certain parts of their operations, like education, advocacy, or non-cannabis product sales, should not be subject to the restrictions of 280E.

Constitutional Challenges: Arguments could be based on constitutional grounds, such as equal protection under the law. Companies might argue that 280E discriminates against legal state cannabis businesses, treating them differently than other legal businesses.

Interpretation of "Trafficking": The critical term in Section 280E is "trafficking," which is a term that might be subject to legal interpretation. Businesses might argue that their activities, mainly those compliant with state laws, should not be considered "trafficking" in the traditional, illegal sense.

State Compliance: Cannabis businesses operating legally under state laws might argue that this compliance should have some bearing on their federal tax treatment, especially as more states legalize cannabis for medical or recreational use.

Changing Legal Landscape: As the legal status of cannabis evolves, with increasing calls for federal legalization or decriminalization, companies might argue that the original intent and applicability of 280E are no longer relevant.

Deductibility of Certain Expenses: Businesses might also argue for a more nuanced interpretation of what constitutes "ordinary and necessary" business expenses, which are typically deductible under other circumstances. They might seek to differentiate between expenses directly related to cannabis production and sales versus broader operational expenses.

Cost of Goods Sold (COGS) Adjustments: Another area of contention is calculating the Cost of Goods Sold (COGS), which is allowable under 280E. Companies might argue for a broader interpretation of COGS to include more expenses.

Impact on Legal State Markets: Arguments could be made about the broader economic and social impact 280E on legal state markets, potentially influencing a more favorable interpretation or application of the law.

Some of the various legal arguments can center around the following. It's important to note that these arguments are often complex and can be subject to differing interpretations by courts and tax authorities. The outcome of such challenges can have significant implications for the companies involved and the broader legal cannabis industry in the United States:

• Nature of Business Activities: Trulieve might argue that some of their operations, such as non-cannabis product sales or educational activities, should not be subject to 280E restrictions.
• Constitutional Grounds: They could challenge 280E on constitutional grounds, claiming unequal treatment compared to other legal businesses.
• Definition of "Trafficking": Trulieve may contest the interpretation of "trafficking," arguing that their state-compliant activities should not be equated with illegal trafficking.
• State Law Compliance: The company could argue that compliance with state cannabis laws should influence their federal tax treatment.
• Evolving Legal Landscape: Given the changing legal status of cannabis, Trulieve might contend that 280E's applicability is outdated.

Application to Trulieve's Operations:

• Specific Business Activities: Trulieve's argument could hinge on the specific nature of their operations, emphasizing aspects that might fall outside the traditional scope of 280E.
• State Compliance and Legal Status: Trulieve might highlight this compliance as a basis for different tax treatment as a company operating legally within multiple state frameworks.
• Impact on Financials: Successfully challenging 280E could significantly improve Trulieve's financial position, freeing up capital for growth and operational efficiency.

Broader Implications:

• Industry-Wide Impact: A favorable outcome for Trulieve could lead to broader changes in how the cannabis industry is taxed and regulated at the federal level.
• Risk Factors: This strategy involves risks, including potential denial of the claims by the IRS and the possibility of prolonged legal disputes.

Cresco Labs' Strategic Focus Yields Strong Gains: resetting to the Core Markets for Enhanced profitability and Growth

Cresco Labs (CRLBF) 3Q23 Revenue of $190.56M (-9.5% Y/Y) beats by $7.21M and Adjusted EBITDA of $49 million, and 26% of revenue, up 21% sequentially as adjusted EBITDA margin improved 528 bps. 

Cresco Labs' 3Q23 earnings call highlighted the company's strategic focus on core markets, brands, and products, termed the "Year-of-the-Core." This strategy aimed to enhance value through bottom-line growth, significantly improving margins, profitability, and preparedness for future opportunities. Overall, Cresco Labs' 3Q23 earnings call reflects a solid strategic focus on core markets and efficiency, with significant improvements in financial metrics suggesting a bullish outlook, albeit with considerations for the impact of market exits and short-term revenue fluctuations. The CEO, Charles Bachtell, emphasized the success of the "Year-of-the-Core" strategy, stating, "By growing revenue from our core states to effectively balance strategic rationalizations, we've held revenue roughly flat while eliminating over $40 million in annualized operating costs." CFO Dennis M. Olis highlighted the direct impact of core initiatives on margins, profitability, and cash flow. There is more work to do with a continued focus on core markets and rationalization of margin-dilutive operations. That said, there are now expectations of a QoQ revenue decline in 4Q23 due to strategic exits and seasonal trends but with ongoing efficiency improvements. Like others, there is an emphasis on cash generation and shareholder value creation.

Key Financial Highlights

• Revenue: Generated $191 million, slightly down from 1Q23 but balanced by retail growth and performance in core markets.
• Gross Profit and Margin: Adjusted gross profit of $96 million with a gross margin of 51%, marking a nearly 500 basis points increase from 1Q23.
• Operating Expenses: Adjusted SG&A expenses reduced by $10 million from 1Q23, totaling $57 million in Q3.
• EBITDA: Adjusted EBITDA reached $49 million, 26% of revenue, a significant increase from 1Q23.
• Operating Cash Flow: $41 million in Q3, up $37 million from 1Q23.
• Cost Reductions: Over $40 million in annualized operating cost savings.

Strategic Initiatives and Performance

• Geographic Footprint: Focused on core markets with significant cash flow potential, divesting from less profitable operations.
• Branded Product Leadership: Maintained the top position in branded flower and concentrates, with solid performance in key markets.
• Retail Productivity: Operated 70 stores, generating nearly $120 million, with efficient processes and technology driving cost reductions.

Implications and Analysis

1. Bullish Outlook: The company's strategic focus on core areas and disciplined cost management suggests a strong bullish potential, with significant improvements in key financial metrics.
2. Market Positioning: Cresco Labs' leadership in branded products and retail productivity positions it favorably in a competitive market.
3. Growth Potential: The company's ability to maintain revenue while reducing costs indicates potential for efficient growth and scalability.
4. Regulatory Environment: The legalization trend in states like Ohio presents new opportunities for market expansion and increased revenue streams.

Contrasting Points: While beneficial for margins, the decision to exit specific markets could limit short-term revenue growth potential. Specifically, they exited their operations in California, Maryland, and Arizona. The overarching reason for these exits appears to be a strategic refocusing on markets where Cresco Labs has a significant market share and can generate substantial cash flow. This aligns with their strategy of optimizing or rationalizing areas of margin dilution in their footprint, essentially concentrating on their most profitable and strategic markets to improve overall financial performance. Here's a breakdown of why these decisions were made:

• California:  Cresco Labs scaled back and restructured its operations in California. The California cannabis market is known for its intense competition and regulatory challenges, which might have influenced their decision to restructure their presence in the state.
• Maryland:  The company sold its subscale Maryland processing operation. This decision could be attributed to the operation's scale not being large enough to justify continued investment or not aligning with the company's core strategic focus.
• Arizona:  Post the quarter's end, Cresco Labs divested their remaining Arizona assets for approximately $7 million in cash. This decision might have been influenced by market saturation, regulatory challenges, or the assets not fitting into their strategic focus on core markets with higher margins and cash flow potential.

These states are highlighted due to their material market share and significant cash flow generation for Cresco Labs. The focus on these core markets is part of the company's strategy to optimize profitability and efficiency, ensuring they invest in areas with the highest potential for growth and return on investment. On the call, the company talked about the following states:

• Ohio:  Mentioned as a significant market, especially with the recent legalization of adult-use cannabis, indicating a potential for growth and increased market share.
• Florida:  Cresco Labs has been expanding in Florida, opening new stores, and driving share gains in the state. Florida represents a large and growing medical cannabis market with potential for future adult-use legalization.
• Pennsylvania:  The company has focused on improving its market position in Pennsylvania, opening new retail locations, and growing its retail share.

MariMed Momentum: Navigating Growth and Innovation Amidst Market Shifts

We have not previously looked at MeriMed but find the opportunity attractive in a better environment for cannabis stocks. Despite facing increased competition and macroeconomic challenges, MariMed's earnings call reflects a company experiencing robust growth, strategic expansion, and product innovation. The company's revised financial outlook and strategic investments focus on long-term growth and market leadership. MariMed's earnings call, led by Jon Levine, CEO, President, and Interim CFO, reported a strong quarter of revenue growth, marking the 15th consecutive quarter of positive adjusted EBITDA. The growth was primarily driven by the core wholesale businesses in Maryland and Massachusetts, along with new dispensaries reaching maturity. The company remains on track for positive operating cash flow for the fourth consecutive year.

Strategic Achievements and Quarterly Performance

• Adult Sales in Maryland: began on July 1, significantly boosting sales, especially in the Annapolis dispensary.
• Expansion in Illinois: Opened the fifth dispensary in Illinois, with plans to double dispensary count in the state.
• New Processing Facility: Received occupancy certificate for a new facility in Mount Vernon, Illinois, with sales expected to ramp up for the holiday season.

Retail and Wholesale Business Update (Tim Shaw, COO)

• Retail Revenue: Increased 2% year over year but decreased 1% sequentially.
• Wholesale Revenue: Reported $13.6 million, a 51% increase year over year and 24% sequentially.
• Product Launches and Marketing: Introduced new products and marketing initiatives, including partnerships and seasonal offerings.

Financial Overview (Rene Gulliver Head, Business Development)

• Revenue: $38.8 million in the quarter, a 14% year-over-year increase, and a 6% sequential increase.
• Gross Margin: Non-GAAP gross margin was 45%, a decline from the previous year due to increased competition and macroeconomic pressures.
• Operating Expenses: Non-GAAP operating expenses were $12.8 million, up from $8.7 million in the previous year.
• Adjusted EBITDA: $6.1 million in the quarter, down from $8.6 million in the previous year.
• 2023 Financial Outlook: Revised targets due to delayed dispensary openings and increased operating costs.

CEO's Concluding Remarks (Jon Levine)

• Strategic Execution: Despite challenges, the company executes its strategic plan effectively.
• Future Growth: Anticipates continued top-line growth and margin improvements in 2024.
• Industry Leadership: Emphasizes the company's role as an industry thought leader and advocacy for regulatory changes.

Implications and Analysis

1. Growth Trajectory: MariMed's consistent revenue growth and positive EBITDA indicate a strong growth trajectory, especially in core markets.
2. Strategic Expansion: The expansion in Maryland and Illinois, including new dispensaries and processing facilities, positions the company for increased market share and revenue.
3. Product Innovation: Introducing new products and marketing strategies demonstrates adaptability and potential for capturing a more significant market segment.
4. Challenges and Opportunities: While facing increased competition and macroeconomic pressures, MariMed's strategic initiatives and revised financial outlook suggest resilience and potential for future growth.
5. Regulatory Environment: Advocacy for regulatory changes, like eliminating 280E, could significantly impact future profitability and industry positioning.

Diverging Opinions or Data Points

• The decline in gross margin and adjusted EBITDA might raise concerns among investors about the company's short-term profitability.
• The revised 2023 financial outlook, with lower EBITDA targets, could be viewed as a cautious approach, reflecting current market challenges and strategic investments for future growth.

MariMed made several notable changes to its financial outlook for 2023. These changes reflect adjustments based on recent performance, market conditions, and strategic decisions. These changes indicate a cautious yet realistic approach by MariMed in adapting to current market dynamics, operational challenges, and strategic growth initiatives. The company appears to be recalibrating its expectations in light of operational realities while focusing on long-term growth and profitability. The fundamental changes to their financial outlook include:

Revenue Targets: The revised revenue range is now $148 million to $150 million. The lower end of this range aligns with current trends, while the higher end anticipates the impact of Illinois wholesale operations coming online in Q4.

Gross Margin: The non-GAAP gross margin expectation has been adjusted to approximately 45%. This is lower than the initially guided 48%, attributed to delayed dispensary openings, increased operating costs, and other factors impacting margins.

Adjusted EBITDA: The new target range for non-GAAP adjusted EBITDA is $27 million to $32 million, down from the previously guided range of $32 million to $35 million. This adjustment is seen as a delay in generating EBITDA into 2024 rather than a long-term concern.

Capital Expenditures (CapEx): The CapEx forecast has been reduced from $22 million to $25 million, down from the previous guidance of $30 million. This reduction is due to construction delays, with the expectation that the remainder of the original guidance will be spent in 2024 to complete the expansion of cultivation and processing facilities in Maryland, Illinois, and Missouri.