4FRONT VENTURES CORP. Investors should read the following discussion in conjunction with the unaudited financial statements and notes thereto included under Part 1, Item 1 of this Quarterly Report on Form 10-Q. In addition, investors should refer to our audited consolidated financial statements and notes thereto and related Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 .
Disclosure Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking information about the Company that is intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1955. Forward-looking statements are statements that are not historical facts. Words such as "guidance," "expect," "will," "may," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "suggests," "potential" and similar expressions are intended to identify forward-looking statements. There statements include information regarding our plans, strategies, and expectations of future financial performance and prospects. Forward-looking statements are not guarantees of performance. These statements are based upon the current beliefs and expectations of our management and are subject to significant risk and uncertainties that could cause actual results to differ materiality from those expressed in, or implied or projected by, the forward-looking information and statements. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot assure investors that the expectations will prove to be correct. Among the factors that could cause actual results to differ materially from the expectations are acts of war or terrorism and the impact on the social and economic conditions inthe United States , the effects of the COVID pandemic, and changes in the legalization of marijuana acrossthe United States . More information on factors that could cause actual results to differ materially from those anticipated is included from time to time in our reports filed with the Securities and Exchange Commissions, including our Annual Report on Form 10-K for the year endedDecember 31, 2021 . New risk factors emerge over time and it is not possible to predict all such risk factors, or to assess the impact such risk factors have on the business. We undertake no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Overview4Front Ventures Corp. has two primary operating segments: THC Cannabis and CBD Wellness. With regard to its THC Cannabis segment, as ofSeptember 30, 2022 , the Company operates six dispensaries inMassachusetts ,Illinois , andMichigan , primarily under the "MISSION" brand name and nine production and cultivation facilities inMassachusetts ,Illinois andCalifornia . The Company's six "MISSION" branded dispensaries are located inBrookline, MA ,Georgetown, MA ,Worcester, MA ,South Shore (Chicago ), IL,Calumet City, IL , andAnn Arbor, MI. TheGeorgetown, MA andWorcester, MA locations are co-located with the Company's cultivation facilities in those towns. 4Front operations are structured in key geographic locations acrossthe United States to scale operations efficiently and position the company for future growth opportunities as cannabis legalization efforts continue across theU.S. and federally. Management intends to continue scaling operations inIllinois ,Massachusetts , andCalifornia to increase its market share. The Company has made significant investments in manufacturing facilities in each of these locations. The Company acquired a new cultivation facility inHolliston, MA in theNew England Cannabis Corporation ("NECC") acquisition (Note 5) inJanuary 2022 which doubled the Company's cultivation footprint in theMassachusetts market. During 2022, the Company has also ramped up production at itsCommerce facility which opened in January and is already selling into more than 200 retailers in the state. In additions to scaling and driving 25 --------------------------------------------------------------------------------
operational effectiveness, the Company will also focus on developing trusted brand products to grow revenue, build customer loyalty and market share.
The Company's nine production and cultivation assets differ by state. InMassachusetts , the Company operates an indoor cultivation facility inWorcester, MA (~4k square feet of flowering canopy), an indoor cultivation and production facility inHolliston, MA (~15k square feet of flowering canopy), and an indoor cultivation and production facility inGeorgetown, MA (~10k square feet of flowering canopy). InIllinois , the Company operates an indoor cultivation and production facility inElk Grove , IL (~9k square feet of flowering canopy). Finally, inCalifornia the Company operates a production facility inCommerce, CA (~170k square feet of production and manufacturing space), a greenhouse cultivation facility in Monterrey County, CA (~80k square feet), and outdoor, hoophouse and nursery cultivation facilities inWatsonville, CA (totaling ~240k square feet). Also, as part of its THC Cannabis segment, the Company leases real estate and sells equipment, supplies and intellectual property to cannabis producers in the state ofWashington . The Company's CBD Wellness segment is focused upon its ownership and operation of its wholly owned subsidiary,Pure Ratios Holdings, Inc. ("Pure Ratios"), a CBD-focused wellness company inCalifornia , that sells non-THC products throughoutthe United States . While marijuana is legal under the laws of severalU.S. states (with varying restrictions), the United States Federal Controlled Substances Act classifies all "marijuana" as a Schedule I drug, whether for medical or recreational use. UnderU.S. federal law, a Schedule I drug or substance has a high potential for abuse, no accepted medical use inthe United States , and a lack of safety for the use of the drug under medical supervision.
Recent Developments
Asset Acquisition of
On
COVID-19 Pandemic
InMarch 2020 , theWorld Health Organization ("WHO") declared COVID-19 a global pandemic, andthe United States declared a national emergency with respect to COVID-19. Management continues to actively monitor the developments regarding the pandemic and the impact the pandemic could have on our business, results of operations, financial condition, and most importantly the health and safety of our workforce. Given the continued volatility of the COVID-19 pandemic and the global responses to curb its spread, we are not able to estimate the effects of the COVID-19 pandemic on our results of operations, financial condition, or liquidity for 2022. Any recovery from negative impacts to our business and related economic impact due to the COVID-19 pandemic may also be slowed or reversed by a number of factors, including the current widespread resurgence in COVID-19 infections attributable to the Omicron variant, combined with the seasonal flu. As such, we are unable to reasonably estimate the duration of the pandemic or fully ascertain its long-term impact to our business.
War in
InFebruary 2022 , theRussian Federation andBelarus commenced a military action with the country ofUkraine . As a result of this action, various nations, includingthe United States , have instituted economic sanctions against theRussian Federation andBelarus . Further, the impact of this action and related sanctions on the world economy are not determinable as of the date of these financial statements. The specific impact on our financial condition, results of operations, and cash flows is also not determinable as of the date of these financial statements. 26 --------------------------------------------------------------------------------
Critical Accounting Policies and use of Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance withU.S. generally accepted accounting principles ("U.S. GAAP"). Critical accounting policies and estimates are identified and discussed in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , as filed with theSEC onApril 18, 2022 . Although we believe our estimates and judgments are reasonable, they are based upon information available at the time the judgment or estimate is made. Actual results may differ significantly from estimates under different assumptions or conditions.
Results of Operations
Three Months Ended
The following table sets forth our consolidated statement of operations for the three months endedSeptember 30, 2022 and 2021, and the change between the two years ($ in thousands): For the Three Months Ended September 30, Change 2022 2021 $ % Revenue from Sale of Goods$ 29,067 $ 23,126 $ 5,941 26% Real Estate Income 3,407 2,815 592 21% Total Revenues 32,474 25,941 6,533 25% Cost of Goods Sold (17,427) (10,269) (7,158) 70% Gross profit 15,047 15,672 (625) 4% Total Operating Expense 14,530 16,596 (2,066) (12)% Income (Loss) from Operations 517 (924) 1,441 156% Total Other income (expense), net (5,796) 871 (6,667) (765)% Net Loss Before Income Taxes (5,279) (53) (5,226) 9860% Income Tax Expense (3,322) (4,541) 1,219 27% Net Loss$ (8,601) $ (4,594) $ (4,007) 87% The Company has been focused on optimizing its operations, leveraging the assets acquired through acquisitions and realizing added synergies from expanding the size of its overall business and further vertically integrating its operations to achieve profitability. Revenue from sale of goods for the three months endedSeptember 30, 2022 was$29.1 million , an increase of$5.9 million or 26% compared to the three months ended September 30, 2021. In Q3 2022, wholesale and retail revenue was 26% and 66% of total revenue, respectively, as compared to 1% and 83% in the same period in 2021. Real estate income was 12% and 16% for the three months endedSeptember 30, 2022 and 2021, respectively. Revenue from retail sales for the three months endedSeptember 30, 2022 was$21.5 million , which is flat as compared to the three months endedSeptember 30, 2021 . Increases inMassachusetts retail revenue were tempered by softness in retail revenues inIllinois andMichigan as compared to the three months endedSeptember 30, 2021 . Revenue from sale of wholesale goods for the three months endedSeptember 30, 2022 was$7.8 million , an increase of$6.0 million or 395% compared to the three months endedSeptember 30, 2021 . The increase is primarily attributable to the addition of theCalifornia wholesale business, growth inIllinois , and strong wholesale performance inMassachusetts as our brands continue to resonate with consumers outside our own dispensaries. 27 -------------------------------------------------------------------------------- Finally, the addition of the newHolliston, Massachusetts cultivation facility added in the NECC acquisition has positioned the Company to aggressively expand further into theMassachusetts wholesale market.
Real Estate Income
Real Estate Income (Note 6) from leasing cannabis production facilities for the three months endedSeptember 30, 2022 was$3.4 million , an increase of$0.6 million or 21% as compared to the three months endedSeptember 30, 2021 . This increase in real estate income is attribute to new subleases of building space inIllinois andCalifornia . Gross Profit Gross profit is calculated as revenue less cost of goods sold ("COGS"). COGS includes the direct costs attributable to the cultivation, production, manufacturing and purchase of the products sold. These costs include the direct cost of labor, seeds, growing material, raw materials and packaging, as well as other indirect costs such as utilities and supplies used in the growing process, post-harvest costs, indirect labor for individuals involved in the growing, quality control and inventory processes as well as certain costs related to its facilities. In addition to market fluctuations, cannabis costs are affected by various state regulations that limit the sourcing and procurement of cannabis products. The change in regulatory environments may create fluctuations in gross profit over comparative periods. Gross profit for the three months endedSeptember 30, 2022 was$15.0 million or 46% of revenue compared to$15.7 million or 60% of revenue for the three months endedSeptember 30, 2021 . The decrease in gross profit percentage of 14% is primarily due to decreased pricing across the Company's markets. The decrease in gross profit margin has been mitigated by increases in retail sell-through of the Company owned produced products primarily inIllinois andMassachusetts . Improvements in flower yields and quality led to increases in revenue, market share, and gross margin inMassachusetts for the three months endedSeptember 30, 2022 . In late Q3 2022, theIllinois has experienced similar improvements in flower yields and quality. Total Operating Expenses Operating expenses consist of selling and marketing expenses, general and administrative expenses, depreciation and amortization, transaction and restructuring expenses, and equity based compensation expense. Total operating expenses for the three months endedSeptember 30, 2022 were$14.5 million , a decrease of$2.1 million or 12%, as compared to the three months endedSeptember 30, 2021 . This decrease is primarily driven by a decrease in equity based compensation expense of$1.7 million as a result of a number of terminations of individualswho held stock options resulting in lower compensation expense.
Total Other Income (Expense), net
Other Income (Expense) consists primarily of interest income, interest expense, change in fair value of derivative liability, and loss on litigation settlement. Total Other Income (Expense) for the three months endedSeptember 30, 2022 was($5.8) million , as compared to$0.9 million for the three months endedSeptember 30, 2021 . This is primarily driven by a decrease in other income attributable to an increase in interest expense of$1.6 million and a decrease in the change in fair value liability of$2.9 million . The increase in interest expense is attributable to the$16 million of incremental debt added to finance the NECC acquisition (Note 5), which resulted in an increase of$0.4 million in interest expense and increased interest incurred related to the promissory notes used to finance the Island and NECC acquisitions. During the three months endedSeptember 30, 2021 , the Company recorded a$3.3 million gain on the fair value of its derivative liability. 28
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Nine Months Ended
The following table sets forth our consolidated statement of operations for the nine months endedSeptember 30, 2022 and 2021, and the change between the two years ($ in thousands): For the Nine Months Ended September 30, Change 2022 2021 $ % Revenue from Sale of Goods$ 77,638 $ 67,658 $ 9,980 15 % Real Estate Income 9,323 8,374 949 11 % Total Revenues 86,961 76,032 10,929 14 % Cost of Goods Sold (46,144) (30,210) (15,934) 53 % Gross profit 40,817 45,822 (5,005) 11 % Total Operating Expense 45,640 45,725 (85) - % Income (Loss) from Operations (4,823) 97 (4,920) 5072 % Total Other income (expense), net (6,416) (11,448) 5,032 44 % Net Loss Before Income Taxes (11,239) (11,351) 112 1 % Income Tax Expense (9,802) (10,545) 743 7 % Net Loss$ (21,041) $ (21,896) $ 855 4 % Revenue from sale of goods for the nine months endedSeptember 30, 2022 was$77.6 million , an increase of$10.0 million or 15% compared to the nine months endedSeptember 30, 2021 . Wholesale revenue was 18 % and 5% for the nine months endedSeptember 30, 2022 and 2021, respectively. Retail revenue was 71% and 84% for the nine months endedSeptember 30, 2022 and 2021, respectively. Real estate income was 11% for the nine months endedSeptember 30, 2022 and 2021. Revenue from retail sales for the nine months endedSeptember 30, 2022 was$61.8 million , an decrease of$1.8 million or 3% compared to the same period in 2021. Increases inMassachusetts retail revenue were offset by softness in retail revenues inIllinois andMichigan . Revenue from sale of wholesale goods for the nine months endedSeptember 30, 2022 was$15.9 million , an increase of$11.8 million or 238% compared to the same period in 2021. The increase is primarily attributable to the addition of the CA wholesale business inJanuary 2022 , coupled withIllinois andMassachusetts strong wholesale performance as our brands continue to resonate with consumers outside our own dispensaries. Finally, the addition of the new cultivation facility added inMassachusetts from the NECC acquisition has positioned the Company to aggressively expand further into theMassachusetts wholesale market. Real Estate Income Real Estate Income from leasing cannabis production facilities for the nine months endedSeptember 30, 2022 was$9.3 million , an increase of$0.9 million or 11% compared to the$8.4 million recognized for the nine months endedSeptember 30, 2021 . In 2022, the increase in real estate income is attribute to new subleases of building space inIllinois andCalifornia .
Gross Profit
Gross profit for the for the nine months endedSeptember 30, 2022 was$40.8 million or 47% of revenue compared to$45.8 million or 60% of revenue for the nine months endedSeptember 30, 2021 . The decrease in gross profit percentage of 13% is primarily due to decreased pricing across the Company's wholesale and retail markets. The 29
-------------------------------------------------------------------------------- decrease has also been mitigated by increases in retail sell-through of the Company owned produced products primarily inIllinois andMassachusetts . Additionally, improvements in flower yields and quality led to an increases in revenue, market share and gross margin inMassachusetts for the nine months endedSeptember 30, 2022 . Late in Q3 2022, theIllinois cultivation facility experienced similar improvements in yields and quality.
Total Operating Expenses
Operating expenses consist of selling and marketing expenses, general and administrative expenses, depreciation and amortization, transaction and restructuring expenses, and equity based compensation expense. Total operating expenses for the nine months endedSeptember 30, 2022 were flat at$45.6 million as compared to the same period in 2021.
Total Other Income (Expense), net
Other Income (Expense) consists primarily of interest income, interest expense, change in fair value of derivative liability, amortization of loan discount, and loss on litigation settlement. Total Other Income (Expense) for the nine months endedSeptember 30, 2022 was($6.4) million , as compared to($11.4) million for the nine months endedSeptember 30, 2021 . As part of the 2022, contingent consideration from the OM acquisition, the Company determined it was no longer probable the milestones would be reached. This resulted in a$2.4 million gain on the contingent consideration to be recognized. During the nine months endedSeptember 30, 2021 , there was a loss on a lease termination of$1.2 million and a debt to equity conversion that resulted in a loss of$2.9 million . There were no similar losses recorded in the comparable 2022 period.
Non-GAAP Financial and Performance Measures
In addition to providing financial measurements based on GAAP, we provide additional financial metrics that are not prepared in accordance with GAAP. Management uses non-GAAP financial measure, in addition to GAAP financial measures, to understand and compare operating results across accounting periods, for financial and operational decision making, for planning and forecasting purposes and to evaluate the Company's financial performance. Management uses the non-GAAP measurement of adjusted EBITDA, which we believe reflects our ongoing business in a manner that allows for meaningful comparisons and analysis of trends in the business, as it facilitates comparing financial results across accounting periods. We also believe that this non-GAAP financial measure enables investors to evaluate the Company's operating results and future prospects in the same manner as management. This non-GAAP financial measures may also exclude expenses and gains that may be unusual in nature, infrequent or not reflective of the Company's ongoing operating results. As there are no standardized methods of calculating non-GAAP measures, our methods may differ from those used by others, and accordingly, the use of these measures may not be directly comparable to similarly titled measures used by others. Accordingly, non-GAAP measures are intended to provide additional information and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. Adjusted EBITDA Adjusted EBITDA is a financial measure that is not calculated in accordance withU.S. GAAP. Management believes that because adjusted EBITDA excludes (a) certain non-cash expenses (such as depreciation, amortization and stock-based compensation) and (b) expenses that are not reflective of the Company's core operating results over time (such as restructuring costs, litigation or dispute settlement charges or gains, and transaction-related costs), this measure provides investors with additional useful information to measure the Company's financial performance, particularly with respect to changes in performance from period to period. The Company's management uses adjusted EBITDA (a) as a measure of operating performance, (b) for planning and forecasting in future periods, and (c) in communications with the Company's board of directors concerning the Company's financial performance. The Company's presentation of adjusted EBITDA is not necessarily comparable to other similarly titled captions of 30 -------------------------------------------------------------------------------- other companies due to different methods of calculation and should not be used by investors as a substitute or alternative to net loss or any measure of financial performance calculated and presented in accordance withU.S. GAAP. Instead, management believes adjusted EBITDA should be used to supplement the Company's financial measures derived in accordance withU.S. GAAP to provide a more complete understanding of the trends affecting the business. Although adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, adjusted EBITDA has limitations as an analytical tool, and investors should not consider it in isolation or as a substitute for, or more meaningful than, amounts determined in accordance withU.S. GAAP. Some of the limitations to using non-GAAP measures as an analytical tool are (a) they do not reflect the Company's interest income and expense, or the requirements necessary to service interest or principal payments on the Company's debt, (b) they do not reflect future requirements for capital expenditures or contractual commitments, and (c) although depreciation and amortization charges are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and non-GAAP measures do not reflect any cash requirements for such replacements. Adjusted EBITDA is defined by the Company as earnings before interest, taxes, depreciation and amortization, accretion, share-based compensation expense, legal settlement, change in value of derivative liability, foreign exchange gain (loss), loss on lease termination, loss on litigation, other non-cash expenses, and one-time charges related to acquisition costs, financing-related costs, extraordinary pre-opening expenses and non-recurring expenses.
We consider these measures to be an important indicator of the financial strength and performance of our business. The following table reconciles adjusted EBITDA to its closest GAAP measure. For comparative purposes, certain prior year amounts have been reclassified to conform to the current year presentation.
For the nine months ended
Nine months ended September 30, 2022 2021 Net loss (GAAP)$ (21,041) $ (21,896) Interest income (8) (13) Interest expense 15,072 7,894
Amortization of loan discount upon conversion of debt to equity
- 2,915
Income tax expense 9,802 10,545
Depreciation and amortization 6,844 3,668
Accretion of lease liability 11,440 -
Equity based compensation 2,290 7,978
Change in contingent consideration payable (2,393) -
Change in value of derivative liability (3,494) (502)
Acquisition, transaction, and other one-time costs 3,876 4,854
Non-cash inventory adjustment 1,600 -
Non-cash lease amortization 3,258 2,203
Loss on litigation settlement 250 -
Loss on lease termination - 1,210
Adjusted EBITDA (Non-GAAP) $ 27,496 $ 20,891
31
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For the three months ended
Three months ended September 30, 2022 2021 Net loss (GAAP)$ (8,601) $ (4,594) Interest income (6) (2) Interest expense 5,798 2,532 Amortization of loan discount upon conversion of debt to equity - - Income tax expense 3,322 4,541 Depreciation and amortization 2,155 1,502 Accretion of lease liability 4,040 - Equity based compensation 862 2,603 Change in contingent consideration payable - - Change in value of derivative liability (420) (3,345) Commerce facility pre-opening expense - 2,035 Acquisition, transaction, and other one-time costs 866 1,800 Non-cash lease amortization 1,045 438 Loss on litigation settlement 250 - Adjusted EBITDA (Non-GAAP)$ 9,311 $ 7,510 Adjusted EBITDA should not be considered in isolation from, or as a substitute for, net loss. There are a number of limitations related to the use of adjusted EBITDA as compared to net loss, the closest comparable GAAP measure. Adjusted EBITDA excludes:
•Interest income and expense
•Current income tax expense
•Depreciation and amortization expense
•Accretion expense related to a periodic update of the present value of a liability
•Equity based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy
•Legal settlements
•Non-cash change in fair value of derivative liability
•Acquisition, transaction, and other expenses (income), which vary significantly by transaction and are excluded to evaluate ongoing operating results
Liquidity and Capital Resources
As ofSeptember 30, 2022 andDecember 31, 2021 , we had total current liabilities of$69.1 million and$48.8 million , respectively, and current assets of$51.1 million and$50.9 million , respectively, to meet our current obligations. As ofSeptember 30, 2022 , we had a working deficit of$18.0 million , compared to working capital of$2.0 million , as ofDecember 31, 2021 . The decrease of$20.0 million is driven primarily by a decrease in cash and increases in accounts payable and taxes payable, partially offset by increases in accounts receivable, other receivables, and inventory, and decreases in accrued expenses and other current liabilities, derivative liability, and current portion of convertible notes. The Company is an early-stage growth company. It is generating cash from sales and is deploying its capital reserves to acquire and develop assets capable of producing additional revenues and earnings over both the immediate and near term. Capital reserves are being utilized for capital expenditures and improvements in existing facilities, product development and marketing, as well as customer, supplier and investor and industry relations. 32 --------------------------------------------------------------------------------
Historically, the Company has raised capital as needed however there is no guarantee the Company will be able to continue to raise funds in the same manor it has historically.
Cash Flows
Net cash used in operating activities was$2.0 million for the nine months endedSeptember 30, 2022 , a decrease of$5.9 million as compared to$4.0 million of net cash provided by operating activities for the nine months endedSeptember 30, 2021 . The decrease is primarily attributable to increases in working capital and the overall scaling of the Company'sCalifornia operation.
Net cash used in investing activities was$27.0 million for the nine months endedSeptember 30, 2022 , an increase of$14.2 million as compared to$12.7 million of cash used in investing activities for the nine months endedSeptember 30, 2021 . The increase can be attributed to the$24.5 million in cash used to complete the NECC acquisition, partially offset by a reduction in purchases of property and equipment to$2.5 million for the nine months endedSeptember 30, 2022 as compared to$14.0 million spent on property and equipment during the nine months endedSeptember 30, 2021 .
Net Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities was$11.7 million for the nine months endedSeptember 30, 2022 , an increase of$13.3 million as compared to$1.7 million of cash used in financing activities for the nine months endedSeptember 30, 2021 . The increase is attributed to proceeds from the construction finance liability of$16.0 million associated with the NECC acquisition and a$3 million promissory note purchase during the nine months endedSeptember 30, 2022 . This was partially offset by repayments of notes payable during the nine months endedSeptember 30, 2022 of$5.9 million and compared to$3.5 million paid in the comparable 2021 period. Refer to Note 7 for additional discussion.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
We review new accounting standards as issued. Although some of these accounting standards issued or effective after the end of our previous fiscal year may be applicable to the Company, we have not identified any standards that we believe merit further discussion. We do not expect the adoption of any recently issued accounting pronouncements to have a significant impact on our financial position, results of operations, or cash flows.
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