Glass House Brands - Q2 2024

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to Glass House Brands Second Quarter 2024 Investor Call. I would now like to turn the conference over to Mr. John Brebeck, Glass House Brands Vice President of Investor Relations. Please go ahead, sir.

John Brebeck (VP for Investor Relations)

Thank you, operator. Welcome everyone, to the Glass House Brands Second Quarter 2024 conference call for the period ending June 30, 2024. I'd like to remind everyone that matters discussed during today's conference call could constitute forward-looking statements that are subject to the risks and uncertainties relating to Glass House Brands' future financial or business performance. Actual results could differ materially from those anticipated in those forward-looking statements. The risk factors that may affect results are detailed in Glass House Brands' periodic filings and registration statement. These documents may be accessed via the SEDAR+ database. I'd also like to remind everyone that this call is being recorded today, Tuesday, August 13, 2024. And now, I would like to introduce Mr. Kyle Kazan, Co-founder, Chairman, and Chief Executive Officer of Glass House Brands. Kyle, over to you.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Thank you, John. Good afternoon, everyone, and thank you for joining us for today's call. Before discussing our results, I'll refer everyone to our second quarter 2024 press release, where you can review our results in more details. I'd like to start the call by congratulating our cultivation team, led by our Co-founder, Director, and President, Graham Farrar, for their outstanding performance at the recent California State Fair Cannabis Awards. Glass House Farms strain, Lilac Diesel, the star of the show in the Greenhouse Flower Division, was awarded the Best of California Golden Bear Trophy, as well as three gold medals and one silver. In all, Glass House Farms won Golden Bear for the Best of California Greenhouse Flower, Gold Medal for the Most Total Terpenes, Gold Medal for the Highest Ocimene Concentration, Gold Medal for the Highest Terpinolene Concentration, and Silver Medal for the Highest CBGA content.

If these terms are foreign to you, don't worry, and you aren't the only one. Though it is a good reminder that the growers at Glass House need to operate at a PhD level to keep up with the California consumer, budtenders, and buyers, who are the most educated and discerning on the planet. If our growers can satisfy the refined tastes of Californians, then we know they can more than satisfy the rest of the world. Winning the Golden Bear Trophy and multiple gold medals at California State Fair's Cannabis Award is a testament to the exceptional quality and expertise of our cultivation team, as this competition highlights the best of the best in California craft cannabis farms. It is yet another demonstration that we mean it when we say that our aim is to produce premium cannabis at the lowest cost.

Next, I am excited to annoz that we have begun the planning process to bring these same award-winning California cannabis products and experience that Glass House is known for to consumers across the nation. As we've mentioned in the past, we expect Greenhouse 2 to be our next greenhouse expansion. To that end, we've given notice to the Tomato and Cucumber Farm Company to vacate, and they have already moved out of approximately one-third of Greenhouse 2. Since the Farm Bill of 2018 passed and was signed into law, many companies, including large cannabis companies, have entered into the business of selling hemp. The biomass, which is hemp, is defined in the federal statute to mean the plant, Cannabis sativa L. All of the cultivation experience we built would apply just as well in producing high-quality, hemp-derived cannabis in fully federal legal form.

We find the possibility of continuing to serve the California market as we do today in our existing operating greenhouses, and at the same time expanding into a new greenhouse, which can bring our products to the rest of the country, to be quite interesting. There are a few differences in the capital improvements made to a greenhouse to grow hemp-derived cannabis than the cannabis we currently cultivate. This will allow us a longer timeline to decide exactly which of those we will plant, as it is either/or. We are actively having meetings with large distributors of hemp-derived cannabis, and we are considering DTC, or direct-to-consumer products, shipped from our farm in Southern California directly to people in the states which legally allow it.

While we are very excited about the prospects, as growing this plant is right in our wheelhouse, and the market is anxious for California-grown biomass, return on investment drives our ultimate decision. We look forward to having more to report on these exciting developments soon. Turning now to our second quarter of 2024 results. We met or exceeded our guidance across almost all major operating metrics. Record quarterly highs set during the second quarter include consolidated revenue of $54 million, consolidated gross profit of $29 million, wholesale biomass revenue of $39 million, retail revenue of $11 million, biomass production of over 149,000 lbs, biomass sales of over 137,000 lbs, and wholesale biomass gross profit of $23 million. These results speak to the hard work and dedication of our entire Glass House team....

I want to personally thank all of them for their untiring commitment to excellence and sustained continual growth and improvement. On our first quarter call, we stated that we were implementing our learnings from the first two years running Greenhouse 6 into our retrofit plans for Greenhouse 5, and that we expected the Greenhouse 5 ramp to proceed more smoothly than that of Greenhouse 6. Our cultivation team accomplished that and more, as quarter two production from Greenhouse 5 outstripped our expectations in terms of quantity and quality, enabling the team to significantly outstrip our wholesale biomass production guidance for the quarter. At this early stage, Greenhouse 5 is already our most efficient greenhouse. Flower yield per square foot is already significantly higher than Greenhouse 6.

As a result, we have made plans to backport a number of the modifications made in Greenhouse 5 into Greenhouse 6 over the next 6-12 months. The team continues to shine as a gritty group who are constantly willing to experiment with new ways of doing the same things. I'd also like to give a shout-out to our post-harvest processing team, which remarkably increased throughput, keeping up with the additional production of Greenhouse 5. This ensured that post-harvest processing remained efficient. The team managed to keep processing and trimming hours in line with our typical norms, despite the record high volume of production. These often unsung, skilled professionals must expand to fit the needs of the growers and do so successfully to keep the high-quality standards which they've previously set. Kudos, team!

We also integrated 2 cutting-edge Photo Optical Sorters into our production process in the second quarter and early third quarter, marking a significant step forward in automation. The sorters are capable of processing 80 lbs of cannabis per hour, translating to approximately 2,500 lbs per day and 900,000 lbs annually, assuming only 2 shifts per day. We expect these sorters to not only increase throughput, but to also improve sorting accuracy and reduce costs while improving quality through fewer product touches. Innovations such as these continue our tradition of leveraging the best of modern agricultural cultivation technology and applying it to cannabis. As we sell premium greenhouse wholesale cannabis, our objective is to obtain a sales price above the average market price.

Our sales team strives to sell for the best and the highest price every single day, and our consistency and scale is an important tool in accomplishing that. The consistent quality and inventory availability that we provide for a wide variety of strains is a key selling point, and over the past two years, our customers have begun to place a greater value on our reliability, as well as on the ease of picking up most or all of their supply at one location, rather than multiple locations spread out around the state. However, we have also upheld our strategy of meeting market pricing where it is. We believe in our ability to continually improve efficiency, and we are committed to ensuring that Glass House flower is always the undeniable best value in the market.

The second quarter decrease in pricing was due to our sales team continuing to execute this sell at market pricing strategy, and Mark will discuss this in more detail when providing our quarter three and full year guidance. Turning our attention to our retail stores, the retail dispensary strategic pricing plan implemented late in the first quarter helped our stores outperform the California market in the second quarter. While the broader market saw a year-over-year decline of nearly 8% and modest sequential growth of roughly one half of one percent per Headset data, our same store retail revenue grew by nearly 6% year-over-year, a rate that was 14% better than the overall market and by 10% sequentially.

We have completed the rollout of the retail dispensary pricing plan across all dispensaries between mid-February to early March and introduced the Allswell $7.50 price on the shelf and $9.99 taxes paid out the door one-eighth pricing at all Glass House retail locations on March 4th. As a result, transactions at our stores increased by 20% year over year on a same-store basis versus quarter two of 2023. We regard the plan as a velocity play focused on improving customer traffic. The aim is to deliver the best value to the consumer and sell more products, and so far, it has exceeded our expectations. Pricing in the market is still highly promotional, with some brands and retailers giving discounts of up to 50%.

But we are seeing that such aggressive discounting is frequently done on aged inventory, which undermines consumer trust and loyalty. In contrast, we have made it a point to maintain fresh menus and products, which resonates better and creates greater loyalty with today's sophisticated consumers, who closely scrutinize batch freshness dates and product quality. Furthermore, our reputation for paying bills on time and maintaining strong partnerships with brands is making us a preferred retailer. Many retail chains are now forced to operate on Cash on Delivery terms, given their poor payment records, further exacerbating their struggles. The current market environment is starting to favor larger retail chains, while smaller operators with 2-3 stores are finding it more difficult to get favorable pricing from brands and or to offer attractive pricing themselves... Our Allswell brand has played a particularly important role in driving growth in our retail dispensary revenues.

Strong sales of the 14-gram and 1/8 oz packs helped propel Allswell into the top 3 of California flower brands by units sold in the second quarter, per Headset data. The recently introduced Allswell Vapes surpassed expectations in its initial launch, becoming the number 4 selling vape by units in our stores. As a result, we've already made the decision to increase the strains offered from 6-12, and we are stepping up volume production of this product, which is a favorite of younger consumers. Some of you may recall the inventory issues we experienced in our CPG business in the first half of 2022.

We were forced to undertake a BOGO fire sale in the second quarter of 2022, as a total of 52% of our quarter one 2022 CPG inventory was older than three months, with 37% of total CPG inventory aging at six months or more. Our Chief Revenue Officer, Hillel Tash, and his team responded with a disciplined sales and operational planning process, which has been maintained with a consistent focus since then. As of the end of quarter two of this year, inventory older than three months of age accounted for only 9% of total inventory, with product over six months old accounting for only 2%. I am extremely proud of our team's accomplishments. By seeking to build a durable competitive advantage in all areas of our business, we are enhancing advantages that are inherent in our vertically integrated model.

I'm also very optimistic about what the future holds for Glass House Brands, and thank all of you who have supported us as shareholders and creditors. With that, I will turn the call over to our CFO, Mark Vendetti.

Mark Vendetti (CFO)

Thanks, Kyle, and good afternoon, everyone. As a reminder, the results I'm sharing will be filed today. They can be found in our financial statements and MD&A, which are reported in US dollars and prepared according to US GAAP. Briefly recapping our second quarter financial highlights. As Kyle mentioned earlier, net revenue for the second quarter of 2024 was $54 million, coming in at the high end of our guidance of $52 million-$54 million. This represented revenue growth of 21% year-over-year and a sequential increase of 79%, which was driven by record quarterly performance in wholesale biomass revenue and in retail revenue.

Consolidated gross profit was $29 million, or 53% of net revenue, ahead of our guidance of 50% and compared to $24 million or 55% in the second quarter of 2023. The higher gross margin versus our expectation was mainly due to a 19 percentage point increase in wholesale biomass gross margin to 58%, from 39% in Q1, coupled with a 145% quarter-over-quarter increase in wholesale biomass revenue. General and administrative expenses were $17.4 million in Q2 2024, up 33% from $13.1 million last year and up 28% from $13.5 million last quarter.

About 60% of the sequential increase was due to the bonus accrual for projected 2024 performance, with most of the remainder due to an increase in wholesale cannabis sales taxes caused by the $23.1 million increase in sequential wholesale biomass revenue. Sales and marketing expenses were $0.68 million, down from $1 million during the same period last year and up from $0.48 million in Q1. Professional fees of $1.9 million compared to $3.7 million in Q1 2024 and $2.2 million in Q2 2023. The $1.8 million decrease versus Q1 2024 is because incremental expenses were incurred in Q1 2024 from the restatements for 2021, 2022, and the first quarter of 2023, and from legal fees related to litigation.

The costs from completing the restatements did not recur in Q2, and legal fees from litigation decreased. Regarding the Catalyst lawsuit that was dismissed on June 24th, 2024, please note that on August 7th, 2024, 562 Discount Med, Inc. filed a notice of appeal of the judgment of dismissal, following an order granting a motion for judgment on the pleadings without leave to amend. We will discuss further developments in this case as merited. Depreciation and amortization in Q2 2024 were $3.7 million, consistent with Q1, and up slightly from $3.6 million in the same period last year. Adjusted EBITDA was a record high $12.4 million in Q2, above the high end of our guidance of $10 million-$12 million. The increase versus our expectations was due primarily to the higher gross margin discussed earlier.

Operating cash flow was $8.9 million, consistent with our guidance of $8 million-$10 million. Factors affecting operating cash flow included a $4.9 million sequential increase in accounts receivable, caused by increased sales from Greenhouse 5 production, and a $3.3 million increase in inventory. The increase in AR and inventory was somewhat balanced out by a $7.4 million increase in accounts payable and accrued liabilities, and this figure includes the bonus accrual discussed earlier. Now turning to the balance sheet. We started the quarter with $24.4 million in cash and restricted cash, and ended Q2 with $25.9 million, slightly better than our guidance of $25 million. We spent $3.9 million in CapEx in Q2, mainly on completing our Phase Two expansion of Greenhouse Five and expanding nursery capacity in Greenhouse One.

The company also paid $1.9 million in preferred stock dividend payments and $1.9 million in principal on the WhiteHawk loan. Now diving a bit deeper into specific business segments. The core wholesale biomass business achieved $39.1 million in revenue during the quarter, accounting for a record high of 72% of total revenue. This was up 28% year-over-year and up 145% sequentially. The approximate 150,000 lbs of biomass produced was a 45% year-over-year increase. We exceeded the high end of our guidance by almost 20,000 lbs, as Greenhouse Five's first quarter production exceeded our estimates.

Average selling price for the quarter was $283 per lbs, compared to guidance of $330-$335 per lbs, and $340 in Q2 2023. We sold about 138,000 lbs of biomass in Q2, up 53% from last year. Cost per lb was $148 per lb, slightly below guidance of $150 per lb, and versus $139 per lb in the same period last year. As discussed on prior calls, we expected the cost of production in the quarter to be above last year, as we are still in a startup mode for Greenhouse Five. Wholesale gross margin was 58%, despite the lower than anticipated average selling price.

This was our third highest quarterly gross margin on record, behind only 61% in Q2 2023 and 60% in Q3 2023. Retail and CPG revenue combined increased 5% sequentially and 6% year-over-year to $14.9 million, better than guidance and flat sequentially. We are pleased with the progress we saw during the quarter relating to our strategic pricing initiative in retail. Based on Headset data, the California retail cannabis market saw total revenue of $1.05 billion in Q2 2024, reflecting a year-over-year decline of 8%. Although there was a modest seasonal sequential increase of about 0.5%. Price compression continues to be a significant factor in this revenue decline, despite the inflationary macro environment affecting the country as a whole.

The average item price in June decreased by 9% year-over-year to $20.29, while the total number of units saw a slight increase of 1% year-over-year, indicating that consumers continue to purchase cannabis at steady rates. As a result, pricing pressure and competition for shelf space amongst brands in retail and branded CPG space remain acute, and many retailers and brands are facing cash flow and liquidity shortfalls. We expect the situation to deteriorate further throughout the remainder of the year. Second quarter retail revenue was $10.9 million, compared to $9.9 million in the previous quarter, and $10.1 million in Q2 2023. Retail gross margin was 47% Q2, down from 53% Q1.

As we have noted before, it is likely that the strategic pricing plan we implemented earlier this year will result in downward pressure on our retail dispensary margins for the balance of the year. CPG revenue was $4 million, down 6% sequentially, and was up 1% year-over-year, with a gross margin of 22%. Based on California Department of Cannabis Control data, during the first six months of 2024, the number of active mixed light and outdoor cultivation licenses declined by 368, or approximately 61 per month. We estimate roughly 2.4 million sq ft of cultivation left the market during this period, or approximately 400,000 sq ft per month.

Although the number of licenses continue to fall, the rate of decline has slowed considerably compared to 2023, when an average of 174 Mixed Light and Outdoor cultivation licenses left the market on a monthly basis, with an average for the area under cultivation falling by about 900,000 sq ft per month. During the two-year period, beginning July 1, 2022, and ending June 30, 2024, the number of Outdoor and active Mixed Light cultivation licenses declined by 3,422, or 48% to 3,768 active licenses. Now, I'll provide third quarter 2024 guidance for key operating metrics, as well as our outlook for the remainder of the year. This guidance does not contain any impact from potential Greenhouse 2 expansion. Moving into our peak growing season of Q3, and with Greenhouse 5 still ramping up production,...

We expect Q3 revenue to be $65 million-$67 million, an increase of 22% sequentially and 37% year-on-year at the midpoint of guidance. We anticipate Q3 biomass production of 185,000-195,000 lbs, as production levels in Greenhouse 5 have exceeded expectations. This will represent 27% sequential and 87% year-on-year growth at the midpoint of guidance. We expect visibility on Greenhouse 5 production capabilities to improve as we move through the remainder of the year and as we complete several more planting and harvest cycles in the greenhouse. We project that the average selling price for wholesale biomass will be in the range of $280-$285 per lb, versus an average of $283 in Q2 this year and $336 in Q3 2023.

Flower pricing has been weaker than expected since the second half of Q2, and in recent weeks has fallen below the lowest level seen in 2023. In 2022, flower prices bottomed in July and recovered over the remainder of the year, while in 2023, they bottomed in September and October before recovering into year-end. We think that the current level of flower pricing is approaching an economically unsustainable level for many growers. But after rationalization of the prior two years, we realize that surviving cultivators are better operators, and our forecast for the remainder of the year assumes pricing will be between 2022 and 2023 levels.

If our thesis that surviving operators are larger and more efficient growers than those who dropped out of the market in 2022 and 2023 is correct, then it remains to be seen how quickly this round of consolidation will occur and when prices will rebound. We feel that lower prices in the short term favor Glass House over the long term, given our position as the low-cost producer. We also believe it's unlikely prices will remain at these depressed levels over the long run. We project that Q3 2024 cost of production will be $120 per lb, roughly flat versus $118 per lb in Q3 2023. This will be only the second quarter of production from Greenhouse 5, and we are still in the initial ramp-up period.

We expect combined Q3 retail and CPG revenue to increase by a low single-digit percentage versus Q2, as we continue to expect a highly promotional and price-driven landscape. We expect consolidated gross margin to be in the low 50s versus 53% in Q2. Q3 typically sees our highest production in sales of flower versus trim, and that should provide a level of resilience in gross margin. We project that adjusted EBITDA and operating cash flow will be in the $18 million-$20 million range in the third quarter, helping to push our cash balance to $38 million-$40 million by quarter end, a new high since we bought, retrofitted, and began cultivation at the SoCal Farm. Within the quarter, we expect CapEx to come in at approximately $2 million. We will also make $1.9 million in dividend payments and $1.9 million in debt amortization payments.

We provided guidance for fiscal year 2024 during our Q1 2024 earnings call. I'll review that guidance here, along with some revisions we made based on our Q2 results and expected trends for the remainder of the year. We are revising revenue guidance for 2024 down to $205 million-$210 million, versus the previous $215 million-$220 million, which is a 29% year-on-year growth at the midpoint of guidance. This revision is entirely due to the current wholesale biomass pricing environment and the resulting downward revision to our guidance for average wholesale pricing for the remainder of the year. We are reducing projected 2024 adjusted EBITDA to $40 million-$45 million from the previous exceeding $50 million, and moving operating cash flow down to the low $30 million range from the previous mid $30 million range.

Consistent with our previous guidance, we expect cash flow to grow at a slower rate than adjusted EBITDA due to the increased working capital requirements associated with starting up Greenhouse 5. This guidance does not include the $11.5 million ERTC refund we expect to receive later this year. We are revising our guidance range for full-year wholesale biomass production by 50,000 lbs to 575,000-585,000 lbs, which represents a 63% increase over 2023 at the midpoint of guidance, as Greenhouse 5 output has exceeded our original expectations. Cost perlbis projected to be $130, which is lower than the 2023 cost per lb of $136. We are revising our projected average selling price down to $275-$280 per lb versus the prior guidance of between $310 and $315 per lb, due to the current pricing trends as described earlier.

Combined revenues from retail and CPG are projected to increase by mid-single-digit % in the second half of the year, as we expect our retail pricing initiative to drive higher sales as foot traffic builds. In closing, we continue to be laser-focused, delivering against what we can control, which is operational excellence and producing high-quality cannabis at the lowest cost. We are prepared for the difficult California market conditions in wholesale, retail, and the branded business to continue in 2024, and still expect to deliver significant increases in 2024 results versus 2023 as we build our business for the long term. We influence pricing but can't control it. Instead, we focus on what we can control, executing in a difficult environment while delivering record results in the present and striving to continue delivering record-high performances in the future.

If pricing had been consistent with our previous guidance, we'd be raising guidance by $10 million-$15 million for revenue because of improving production from our SoCal farm, and we would not be dropping guidance as we are now. With that, I'll turn it back over to Kyle

Kyle Kazan (Co-Founder, Chairman, and CEO)

Thank you, Mark. I have a few final remarks before we begin the question-and-answer session. On July 22, 2024, the Drug Enforcement Administration, DEA, comment period on its recommendation to reclassify cannabis from a Schedule I to Schedule III drug ended. Over 42,000 public comments were received by the DEA, more than for any other DEA proposal in history. While the public comments were overwhelmingly in favor of the DEA proposal to remove cannabis from Schedule I, it is also clear Americans view rescheduling alone as insufficient.

Almost 77% of the public comments supported removing cannabis from the Controlled Substances Act completely. This makes sense. Over 74% of Americans live in a state where marijuana is legal for either recreational or medical use, and because of this, the American public now sees cannabis as another product like tobacco and alcohol, and not like an illicit or even pharmaceutical drug. Americans are divided on so many issues, but one thing that the vast majority of both Democrats and Republicans agree on is that it is time to reform federal cannabis laws. Our nation has spoken, and it wants complete descheduling at the federal level. So two weeks ago, Graham and I wrote an open letter to President Biden, former President Trump, and Vice President Harris, urging all three of them to make the right choice to embrace descheduling cannabis.

We believe whichever presidential candidate takes on this mission will be rewarded at the ballot box. As such, it's critical, it is critical that the American public know where each of them stands on the federal legalization of cannabis. We also called on President Biden to honor his campaign promises to decriminalize marijuana through descheduling, release nonviolent cannabis prisoners from jail, and expunge cannabis convictions from their records, and to do so immediately. I urge him to fully pardon all of the approximately 3,000 individuals currently incarcerated in federal prison for nonviolent marijuana offenses, many of whom are serving life sentences. The continued incarceration of these individuals prolongs the legacy of the war on drugs and imbrues our justice system.

We have been consistent as an advocate on this issue, including in early 2021, when we urged then-President Trump to pardon Parker Coleman, and there are many others who deserve their freedom, such as Jerry Austin, Jose Valerio Jr., and Jerry Haymon IV. So it is that we were heartened to hear former President Trump say the following at his press conference at Mar-a-Lago last Thursday, quote, "As we legalize it, I start to agree a lot more because, you know, it's being legalized all over the country." He added, "Florida has something coming up. I'll be making a statement about that fairly soon," end quote. If legalization becomes a bipartisan issue, we can only hope that the current momentum towards rescheduling evolves into momentum towards full descheduling. Such a development would be a positive for the entire country.

We recently welcomed Hector De La Torre back to our board of directors. An original member of our board, Hector stepped down in 2023 because of time constraints connected to other commitments. Hector recently expressed his desire to rejoin our board, and I'm extremely happy to welcome him back. He was an impactful board member during his first tenure. He was one of the earliest vocal advocates for cannabis policy reform in California when he was a member of the State Assembly. With his proven track record in public health and public affairs, his expertise will be invaluable as the cannabis industry evolves and we continue to execute on our growth plans. I'd also like to share my thoughts on Investor Sesh 2024, which was held on June 21st at our SoCal farm, concurrent with our annual shareholder meeting.

This was our third annual Investor Sesh and was the biggest and best to date. Attended by over 200 investors, who got a firsthand view of newly retrofitted Greenhouse 5. I want to thank all of you who joined us. We enjoyed spending time and having casual conversation with you, including longtime holders, as well as those who became investors more recently. We have begun preparation for Analysts and Institutional Investor Day on September 12, to be held at our Camarillo, SoCal facility. Many of you have received invitations to this upcoming event, and I hope you can join us for an interactive day of informative sessions and a tour.

Lastly, in regards to the federal legalization of hemp-derived cannabis through the Farm Bill, which I discussed earlier, Glass House Brands has been consistently in favor of consumer-friendly policies like home grow and farmers markets. Therefore, we also believe that the Farm Bill was the right thing to do. We simply want all cannabis to be fully legal and accessible to adults worldwide. With that, I'll hand the call back to the operator for questions.

Operator (participant)

Thank you. If you have a question, please press star one on your telephone keypad. If you wish to remove yourself from the queue, simply press star one again. One moment please, for your first question. Your first question comes from the line of Luke Hannan of Canaccord Genuity. Your line is open.

Luke Hannan (Vice President and Equity Research Analyst)

Thanks, and good afternoon, everyone. I wanted to start with the discussion on hemp-derived cannabis. Kyle, I think you mentioned that you're in conversations right now with several distributors. Of course, you're evaluating the ROI of that opportunity. So I guess my question is, it's a two-part question. One is, how far along exactly are you in these discussions? And then maybe secondly, as part of the ROI discussion, are you concerned that there could be legislation or something similar, some other factor or variable out there that potentially closes the loophole that allows for hemp-derived cannabis to be in the market currently?

Kyle Kazan (Co-Founder, Chairman, and CEO)

So thank you for the question. I would tell you that we've been watching this now for a couple of years. We've seen things and thought maybe that there would be a closing or changing of the law. Thus far, we haven't seen that. And so as we decided on our next expansion, we felt it was high time to go ahead and have those conversations. I would say we're still in the relatively early stages, and I would say that it is quite possible that legislation that was already discussed federally at potentially making some changes, all part of our, our calculus, and risk as we look at this.

Luke Hannan (Vice President and Equity Research Analyst)

Okay.

Graham Farrar (President)

Luke, thanks for the question. Jump in there with one comment. One is, so, you know, I think first and foremost, right, is, we sometimes joke that we're a regulatory company who sells cannabis on the side, so anything that we do would need to be fully compliant with all laws. In our analysis on that, one of the great things about it is, if everything that Glass House is good at on the cultivation side applies... is 100% portable between the two regulatory systems. So whether that's Prop 64, descheduling, or the Farm Bill, what we do and what we're good at is exactly the same because we're working with, for the most part, the same plants.

The other great thing about that is from an ops optionality and from a allocation of capital point of view, what we would do in the greenhouse in terms of a retrofit operations is no different between the two markets. It's really just a different set of regulatory standards. So what we're looking at here would give us basically maximum optionality with minimal increased costs, so that we can be potentially in both markets at the same time. Or if there is a change, as you mentioned, what we would do is we would just pivot back to what we've already been doing for the last eight years. If the change becomes more liberal, then we could pivot further into the Farm Bill side of things.

So it really is, it puts us in an optimal position because our skill set is exactly the same and applies in a 100% portable way between the two regulatory frameworks.

Luke Hannan (Vice President and Equity Research Analyst)

Understood. Thanks for that. And then my follow-up question here, and then I'll pass the line. You mentioned backporting some of the modifications that you have in Greenhouse 5 to 6, and I think that's gonna take place over the next 6-12 months. How, I guess, significant are these modifications? Is there, you know, a lot of capital that's acquired to make these modifications, or is it simply just, you know, timing and process and that sort of thing?

Graham Farrar (President)

Yeah, I can take that one. So, the modifications, let's see, how to frame it. I would say that they're kind of intermediate terms. We're certainly not talking about a greenhouse retrofit. I'll give you a tangible example. In Greenhouse 6, when we first set it up, we had three gutters per row, and we, you know, thought that was based on our analysis, the initial the ideal spacing. What we did in Greenhouse 5 is we had the same number of plants, but only split them between two gutters. And what we've seen from that is it's less labor because you don't have to work on a center gutter. It's better airflow because there's less restrictions. That's actually more about, for example, more about taking something away than it is putting something in.

So for example, in that, in that, as we go through and harvest, when we have an opportunity and there's a bay that's open for a few days, we're just gonna send in a crew and bring out that third, that center gutter, reposition the other ones, adjust the slurp so the air hole pattern is in an appropriate spot, and we'll just kind of slowly roll through the greenhouse. So, you know, from a CapEx point of view, it's really just labor that we'll insert opportunistically. Another example might be the shade screen that we have in Greenhouse Five, that we found useful in our... It gives us a more dynamic ability to react to changes in light levels.

So now, you know, you're talking something in the kind of $1 million range to retrofit that back in to add that screen to six. So you're talking about, you know, projects, some of which we'll just fit in and some of which will be kind of medium scale, CapEx retrofits that will add to the existing structure. Nothing really needs to get thrown away, and not, certainly not as something that would stop production. We would be running the greenhouse as we did the retrofit.

Luke Hannan (Vice President and Equity Research Analyst)

Okay, great. Thank you very much.

Operator (participant)

Your next question comes from the line of Mike Regan of Excelsior Equities. Your line is open.

Mike Regan (Director of Research)

Hi, Lauren. Thanks for the question. So in terms of the pricing, can you give us some insights into sort of what's driving sort of the lower than expected pricing or what surprised you? Is there, like, greater supply in California or declining demand? You know, and sort of what then reverses or changes that to have that pricing stabilize or increase in the future?

Kyle Kazan (Co-Founder, Chairman, and CEO)

Graham, do you wanna take that from Mike?

Hey, Mike, how you doing?

Graham Farrar (President)

Hey, Mike.

Mike Regan (Director of Research)

Hey, how you doing, dude?

Graham Farrar (President)

Yeah, sure. So, so, you know, I think, I think first thing to say is consistent with our perspective, right? We know that we do not control pricing cycles, and we actually expect there to be cycles as we kind of oscillate between, you know, prices going up and better margins, making more money, and prices going down, which we expect to thin the herd and reduce the supply. As we, as we've mentioned, we see consumption on a unit basis staying, you know, fairly consistent to growing as additional consumers come into the market. So it's kind of gonna be this, this cycle of prices up, great, prices down, long term, great, because we're gonna have a reduction in suppliers. So we've, we've never, never claimed to be able to forecast pricing.

What we've always focused on is the things that we do control, which is our cost and our efficiency and our quality, and those things, thankfully, are forever. So once you make cost savings, you hold on to that regardless of the pricing cycle. So this year, what we saw, is that the pricing declined a bit earlier, and a bit more drastically than it did last year. The crystal ball on that is certainly made out of salt. We were tracking pretty close to estimates in the front half of the year and then saw things fall a bit quicker. You know, it could be expiring licenses out there. If you had a license and you wanted to finish your harvest, you're certainly gonna sell all your product before your license expires, and you can no longer transact.

We're probably seeing some overlap from the Farm Bill and THCA market as there's producers growing in that market that are satisfying some of the demand. And you might have even seen some FOMO, for lack of a better word. At the beginning, you know, the first part of last year, we were seeing massive extinction in terms of licenses leaving the system, and so you might have seen some, you know, people kind of rushing to fill orders in a quickly declining supply side that was a bit more moderate this year.

So in the long term, don't really see it as being an issue and believe that it leaves us even better positioned because the lower prices go, the rarer air that we're in and the fewer comp people and operators who are able to compete with us. So we're confident in our ability to continue to drive down our long-term costs, which is where we're gonna really win, overall.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Mike, I think in the past, we've talked. I owned some pecan farms down in southern Georgia for since before I was in cannabis, and this is the healthy sign of the market in California, which is this is an agriculture commodity. And I would just point out that we're anxious for the walls to come down because we grow it like an agriculture product, and as Graham said, we're focused completely on COGS. The rest of the country is growing closer to $800 a lb, while we're in the low hundreds. So we kind of think we are where the world is going to go eventually, and so this is just sort of what we've been expecting for years and years.

Mike Regan (Director of Research)

Got it. Okay. It sounds like you're still being able to see a lot of demand for the new production out of Greenhouse 5 anyway, so, you know, it's just taking a lower price to clear it. You're still selling all the production, so.

Kyle Kazan (Co-Founder, Chairman, and CEO)

No, no issues in demand.

Graham Farrar (President)

Yeah, yeah. And just to reiterate that, I think we've kind of made an intentional choice that we are going to keep inventories at a level of our choosing, and if that means moving with the market to make sure that the Glass House product is, you know, the undeniable best quality-cost intersection, we're prepared to do that. So again, why we focus on our COGS, is the bigger we get, the more efficient we get, the higher quality, the better consistency, the more competitive we can be.

Mike Regan (Director of Research)

Got it. Okay. And then on Greenhouse 2, I guess you've asked the tomatoes to back out so you can start to convert that. Any thought on just the cost and the timing on that conversion? It sounds like it's already started.

Graham Farrar (President)

Yeah. So, one note on that, it is the process has started. The greenhouse is currently being vacated. Again, you know, the way that we set that greenhouse up would be no different, working towards the cannabis side or the Farm Bill side, so we don't need to make any choices or, you know, bifurcations at this point. We can just do it the way that we normally would. Greenhouse 2 is a bit older of a greenhouse than the 5 and 6, so we do anticipate it being a bigger project from a construction point of view. So timing will be not quite as quick, and the cost will be a bit higher than what we've done before. We'll also probably upgrade some of the supporting infrastructure to bring on that additional square footage.

So we'll be going through kind of, you know, think of it as like a phase two retrofit to bring that next capacity online in whichever market it ends up fitting in.

Mike Regan (Director of Research)

Got it. Great. Thanks a lot.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Thanks, Mike.

Operator (participant)

Your next question comes from the line of Aaron Gray of Alliance Global Partners. Your line is open.

Aaron Gray (Managing Director and Head of Consumer Research)

Hi, good evening, and thank you for the questions here. So first one for me, just wanna attack a little bit differently in terms of potentially going into the hemp category. So you guys are known for kind of growing quality smokeable flower at scale, which is an advantage you guys have for THC. So curious with the potential, you know, change to hemp, how do you think about approaching the market? You know, given hemp, you know, can be geared more towards your derivative products with less focus on the flower side and more competition from outdoors. So wondering if that would have any impact, just in terms of how you would approach the market there? Thank you.

Kyle Kazan (Co-Founder, Chairman, and CEO)

So, excellent question, and what I would tell you is, in discussions that I've been part of, the pricing right now for wholesale flower is higher, decently, than what we're selling our cannabis flower in California for. Now, obviously, it's a commodity, so we're expecting that to move. But there is plenty of demand out there. All you have to do is just Google, and you'll see there's that there's a lot of brands, Cookies, some of the brands that we see out here in, on the shelves have already moved into that. So yes, there's different derivatives of it, but that's the same as you'd find in any dispensary here in California as well.

Aaron Gray (Managing Director and Head of Consumer Research)

Good. All right, great.

Graham Farrar (President)

Yeah-

Aaron Gray (Managing Director and Head of Consumer Research)

Appreciate that. Sorry, go ahead, Graham.

Graham Farrar (President)

I mean, just a reminder that, you know, our big three on the brand side, Glass House Farms flower, Allswell flower, also Allswell edibles, and then Plus on the edibles side. So we, you know, we've got a product catalog that spans the primary products that you see in the Farm Bill side. Obviously, our expertise and where we really excel is on the cultivation of high quality, consistent flower at scale and at, you know, industry-leading cost. I think that everybody in the Farm Bill side of the market will appreciate those things. And then when you grow great flower, you get great byproducts, which help you make great derivative products, as you call them, as well.

I think that, you know, again, one of the great things about this from our perspective is the skills that we've developed over the 8+ years of living in the hardest cannabis market on the planet apply 100% to either regulatory system.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Aaron, you know, a lot of people have been saying... We get a lot of questions about this privately, and we've gotten it for quite a long time. But as you just pointed out, everything we do is pretty sizable, so we're being extremely deliberate, because should we make the decision to go forward this way, we'll be bringing a lot of biomass to the hemp-derived cannabis market.

Aaron Gray (Managing Director and Head of Consumer Research)

Okay, great. Really appreciate that color there. Second question for me, just in terms of Allswell $9.99 out the door, appreciate the color there in terms of the impact for some of the dispensaries and rolling it out to more of the stores there. Just wondering if you could provide some additional color in terms of, you know, expanding that out to third-party retailers. Still sounds like it's a tough environment out there in California, so any update on that in terms of being able to partner with other retailers and having the potential for that $9.99 out the door in stores outside of your own? Thank you.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Thank you again, Aaron. I would tell you that our focus is to stores in which we are managing, that that's something that we can bring to them. We're not anxious to roll it out to every single dispensary in the state.

Aaron Gray (Managing Director and Head of Consumer Research)

Okay. All right, great. Thanks for the call. I'll drop back in the queue.

Operator (participant)

Your next question comes from the line of Scott Fortune of Roth Capital Partners. Your line is open.

Scott Fortune (Managing Director and Senior Research Analyst)

Good afternoon, thanks for the question. Just to follow up on that, on the Allswell strategy here, you said you've seen obviously nice traffic metrics ticked up in your stores, and you've seen other, you know, add-ons for that. How is the average basket size dollar amount kind of? How has that increased or decreased in this kind of tough consumer environment? Just a little more metrics you can provide on the Allswell within your stores and kind of the impact on the value brands that are those offerings in California would be helpful.

Kyle Kazan (Co-Founder, Chairman, and CEO)

So Scott, I'm gonna hand it over to Mark, but as we just finished with the Olympics, and you're an Olympian with a medal, when you watch games, do you actually wear the medal around the house?

Scott Fortune (Managing Director and Senior Research Analyst)

No, but you have had a great showing, obviously.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Sorry, man, I always have to ask because I think of you when I see Americans with Olympic medals.

We're not—you don't deal with many analysts in that—

No?

in that category.

Verify there.

That's, that's cool.

Scott Fortune (Managing Director and Senior Research Analyst)

Right.

Kyle Kazan (Co-Founder, Chairman, and CEO)

So if you just look at, you know, in talking about our stores, so, Allswell flower has become our largest, you know, unit driver in our stores, and I think we had mentioned same store sales for traffic are up 20% since we've kind of gone to this new strategic pricing plan. We have seen our ATVs drop slightly, not significantly, you know, a few percent. And I actually think that's pretty good when you think about how aggressive we've become in pricing, and we've seen, again, the traffic more than make up for the drop in ATV, which is really good.

And even we are not as aggressive outside of our stores, Allswell has now moved into a top three flower brand from a unit basis, so it's being accepted both in our stores and, and outside of our stores at a, at a really strong level. And that's happened, you know, really in a couple of quarters. So we can't be... You know, we're really pleased at what we're seeing out of Allswell.

Scott Fortune (Managing Director and Senior Research Analyst)

I appreciate the color there. And then maybe a follow-up on Graham. Greenhouse 2, remind us, is that the canopy with supplemental lighting already in place? And would you have to update the lighting or kind of use that? And then how does some lighting play into your overall long-term structure a little bit here? ... to complement the growing and bringing down the yield or increasing that yield production from a standpoint within your greenhouses. Just kind of remind us on that Glass House 2, kind of-

Graham Farrar (President)

Yeah

Scott Fortune (Managing Director and Senior Research Analyst)

-structure.

Graham Farrar (President)

Yeah, sure. A great question. Greenhouse 2 is the greenhouse that has existing lighting in it. It has about 11,000 1,000-watt HPS or high-pressure sodium lights in there. Again, great thing with our setup is that we have our three co-generation power plants on site. They were designed to be able to use natural gas and produce electricity cheaper than we can buy it from the grid at, to power those lights. And then in the process of producing that electricity, we also get heat, which we use for climate control within the greenhouses, as well as CO2, which again allows us to be very environmentally friendly and very efficient from a production point of view. So there's two paths that we could take there.

One path is basically to use the existing lights, and they would probably need some rehabilitation since they haven't been used as much as they normally would have, replacing burned-out bulbs and things, you know, of that nature. So not a huge uptick, cleaning things off and making sure that they're all in good working order. The other path would actually be to upgrade the lighting or replace it. LEDs have become much more popular in recent times. They have some great benefits, producing more light for the given amount of electricity or more micromoles per joule, the way that they measure the efficiency there.

They also don't produce heat, and that can be a good or a bad thing, depending on what it is you're trying to do with your climate. So, we'd have optionality there to either keep the cost down and just keep the existing system or to do a partial or full upgrade, depending on what makes the most sense. It'll basically be a balance of CapEx versus OpEx over time, and whatever makes the most sense is what we'll do. And, sorry, the second half of your, second half of your question there. Expectations, one of the big upsides from that is it increases output without increasing consumables other than electricity.

Also, typically, it will increase the ratio that you see, so you have a higher ratio of larger flower, which sells for a higher price. It also puts you potentially in a different pricing category, where a flower with supplemental lights gets even closer and potentially even surpasses the indoor that people clamor for. If you think about taking everything Mother Nature gives you and then adding light to that, is potentially better than either one of those things on its own. And then the other nice thing it does is that it would help level out the season. So rather than kind of the seasonal fluctuations, you see less light being less production.

If you're able to supplement what Mother Nature's giving you with your own lights, you can take some of that seasonality out. And if you look at our pricing, our ASPs over time, you can see that having additional lbs to sell in some of the lower production times of the year has its own benefit because pricing tends to be higher as well.

Scott Fortune (Managing Director and Senior Research Analyst)

Thanks. I appreciate the color, Graham. Thanks.

Operator (participant)

Your next question comes from the line of Howard Penney of Hedgeye Risk Management. Your line is open.

Howard Penney (Managing Director and Sector Head)

Thanks very much. So the question, Graham, I just wanted to see if I can summarize the hemp opportunity. So you said the plan is 100% portable. The hemp is 100% portable between the two plants in terms of the growing. The biggest difference is the rules you follow, so there's no taxes, consumers use credit cards, there's a DTC opportunity, and there's better wholesale prices. All that suggests that hemp can have significantly higher gross margins than what the company's putting out today. Is that right? And then if that's the case, what would hold you back, or what is holding you back from doing it? And what would you need to see to take advantage of this opportunity? And oh, lastly, one other-

Graham Farrar (President)

Sure.

Howard Penney (Managing Director and Sector Head)

What's the size of the market?

Graham Farrar (President)

Yeah, great question. So, I think there's significantly less regulatory burden on the production. Taking it, you know, kind of section by section, on the production side, there's significantly less regulatory burden. Hemp, a hemp license is $900 and covers a year, and covers unlimited acreage versus, you know, cannabis licensing, which is annual and on a square foot basis. There's less overhead in terms of the things that you need to go through, in terms of tagging plants and removing tags and things like that. So we'd expect the cost of production to be able as the plant to be able to be produced more efficiently without some of those frictions.

On the direct-to-consumer side, you very much, you can see other brands, Cookies being a good example, that are running direct-to-consumer options, where you're able to capture, you know, full margin, similar to how we do in our stores. But I think it's about 21 states that allow a THCA flower to be shipped into them currently. You can use credit cards, you can ship it through the U.S. United States Postal Service. So basically, think of it as regular commerce and maybe think of it not even too different than alcohol, right? Where there's some states that you can ship alcohol into and some states you can't, and that varies on a state-by-state basis. So, we would look to be able to capture those opportunities there.

As Kyle mentioned, you do see some, you know, variance in pricing, state to state. I think we would not necessarily count on that. We would expect to see convergence, particularly with somebody of our scale moving into that. So even if we forecasted pricing to be the same, as we see in cannabis, lower overhead, lower taxes, a broader market, credit cards and all that should, we believe, would produce a, you know, an exciting opportunity. Beautiful thing again, where we sit, it doesn't-- we don't have to choose, right? We can, we can operate in both paths. We have six greenhouses. Three of the greenhouses are currently used, being used for licensed cannabis. The other greenhouses are being tomatoes and cucumbers.

Clearly not the long-term highest and best use, and one of the nice things about the way that we see the market right now is that we would not have to turn off one opportunity, necessarily to turn on the other. So we'll continue to do our analysis, regulations, and compliance will drive our decisions. We'll take advantage of opportunities where they are, where they are. If things change, you know, more conservative, more lenient, then the nice thing is the investments we make into the greenhouses don't change at all, and so we can be pretty dynamic in pivoting to take advantage of wherever the best opportunity is.

Kyle Kazan (Co-Founder, Chairman, and CEO)

And Howard, you know, one question that we've, we know we're gonna get, and we're expecting, and again, we haven't annozd that that's the exact pivot we're gonna do. We are looking very seriously at it. But our feeling also is that once a state legalizes, we haven't seen one go backwards. So our feeling is once people have access to Glass House products legally, it may be hard to actually put that genie back in the bottle, because now you're gonna have to justify why you would do that and take away the right that somebody had started enjoying. So we, we kind of think that this, if we move in quickly and correctly, that might actually make this solidify this law, which again, we always agree with anything that's good for the consumer, and we're very pro-freedom.

Howard Penney (Managing Director and Sector Head)

What's the size of the wholesale market for hemp? Do you know?

Graham Farrar (President)

Tough, tough to get a great read on it. I would say Beau Whitney out of Whitney Economics has probably done some of the best work. The number that I've seen thrown around is a $28 billion market, which, if you believe that, would surpass the size of the licensed cannabis market and probably be somewhere in the order of half to a third the size of the total cannabis market. So it appears to be growing pretty quickly. Again, stats, don't quote, don't quote me on this, but do your research. I've seen numbers upwards of 7,000 hemp dispensaries in Texas.

You can see, you know, if you look at the states that allow THCA flowers, well, hemp-derived, you know, gummies to be shipped to, you're seeing, you know, Texas is the number two most popular state, populous state. Florida, I think, is the number three most populous. New York is the number four most populous. All those currently have laws and standards that would allow this flower and, and edibles to be shipped into them. So the market size is potentially massive, and frankly, it looks more like we would have expected and hoped cannabis to look at this point, you know, five, six years post-Prop 64 in California than the licensed market does. So in many ways, happy to see the liberalization development.

You know, at the end of the day, our goal is to make products that consumers love and help live, help them live better lives. So the more people that have access to cannabis as either for fun or as an alternative to pharmaceuticals, the happier we are, and it's great to see this additional path open up to help make that happen quicker.

Howard Penney (Managing Director and Sector Head)

Awesome. Thanks for your time.

Operator (participant)

Ladies and gentlemen, there are no further questions at this time. I'll turn the call over to Mr. Kazan for closing remarks. Please proceed, sir.

Kyle Kazan (Co-Founder, Chairman, and CEO)

Thank you, operator, and thank you everyone for your interest and for joining us on today's earnings call. Operator?

Operator (participant)

This concludes today's conference call. You may now disconnect.