GLASF - Cultivating Profitable Cannabis

2023-06-14 12:40:00 ET

Summary

• Headwaters' Nick Brandis on one of the largest cannabis cultivators you've never heard of.
• Deciphering cannabis pricing volatility and compression.
• Partnering with Glass House; competition and the illicit market.

Listen here or on the go via Apple Podcasts or Spotify .

• 3:00 - Headwaters' Nick Brandis on one of the largest cannabis cultivators you've never heard of
• 8:00 - Why greenhouses will be the winning method in the long run
• 13:15 - Deciphering cannabis pricing volatility and compression
• 40:15 - Partnering with Glass House ( GLASF ), competition and the illicit market

Recorded May 1, 2023

Transcript

Rena Sherbill: Okay. Nick, welcome to The Cannabis Investing Podcast. Super happy to have you on the show.

Nick Brandis: Thank you so much, Rena. Huge fan and excited to be here.

RS: Yeah, huge fan as well. I was recently given a tour of Headwaters , and really a gift of a day in a beautiful part of California and also touring beautiful plants. And even I think more meaningful behind the physical setup is the story behind Headwaters and how you got started. I don't know if everybody's even heard of Headwaters or know what you do. So I'd be happy if you shared with our audience a bit about your journey to cannabis, Headwater's story and where you find yourself -- where we find ourselves today.

NB: Of course, yeah. Happy to talk to those points. So I've been in the cannabis industry for over five years now. I cut my teeth at first at working at Eaze deliveries or Eaze Technologies for three years from about 4/20/2018 until Q2 2021. And Eaze, for those who aren't familiar, is one of the largest cannabis delivery platforms in the country was certainly one of the early CannaTech Darlings on the space and it has been very successful raising money over the years. And in that -- at Eaze, I was the Director of Corporate Development and Business Intelligence.

Most prominently, my mandate was to run everything related to expansion, end to end, from top of funnel deal flow through deal negotiation and execution, upfront strategy, roadmap planning, et cetera, and then supporting all M&A and fundraising efforts that go along with expansion and growth.

I was there for three years, and then I decided I wanted to try something new and get exposure to a different part of the industry. And I figured were no more valuable place to learn than cultivation. So I made a jump to the opposite side of the value chain from delivery. And I've been at Headwaters for two years as the Head of Corporate Development.

And I joined the business, I think, it was really attractive to me for a few reasons. I think this is a good segue into the Headwaters story. Headwaters besides is a very different company than Eaze, despite being -- beyond just being a cultivation company first and foremost. It also has just a very different upbringing and background.

Headwaters is self-funded still to this day. It is a very, very lean team without the funding of a tech-enabled company like Eaze. And so we're extremely scrappy, extremely lean. And still, we have a very small-cap table of the original founders and owners. Here at Headwaters, we might be one of the -- we are one of the probably the largest operators in California that's flying under the radar that most people don't know and that's for two reasons.

One is, as I mentioned, we've never really raised a round of equity financing to date. So we haven't been seen in the headlines for that reason. And the other is we never really had a brand in the marketplace. We were playing predominantly in the bulk and the agricultural services segments of the market until a little over a year ago when we entered the branded space with the launch of Mr. Zips, which has been extremely successful.

The business was founded really in earnest about 10 years ago by its Founder, Tristan Strauss, who is still the CEO today. And he founded it up in Humboldt, very authentic Humboldt beginnings on a relatively primitive farm. And his background before that, he studied sustainable agriculture at UC Santa Cruz. And he was able to apply his academic and really professional know-how to the cannabis industry and just built a fantastic network of peers and operators up in the Humboldt area.

And soon enough, beyond just being a cultivator himself, he found himself providing consulting in agricultural services to his neighbors, everything from genetics provisioning to management services for their farms, to then bulk distribution of their harvested material. And hence, Headwaters was really born as not just a cultivator, but an agricultural services provider.

And today, in California, I'd say we are a top two greenhouse cultivator in the state, certainly one of the largest trading houses in the state and have one of the more exciting young and up and coming brands.

RS: Can you talk about how big the grow is that you have now? And also, why you chose the space that you're growing in now, how he -- why Tristan came down from Humboldt?

And the other thing that I wanted to ask is your thoughts on not getting outside capital. And if you're on board with that, if that makes sense, and how that makes you think about growing? And I know that was a whole bunch of questions, so have in mind for us.

NB: Of course. Yeah, so we have 26 acres of cultivation canopy under our management or ownership. Of that, about two acres is dedicated to just nursery, which means clone production. We have the largest commercial nursery in the state. We cut and root around 100,000 clones on a weekly basis, much of which we sell to large contracted partners who we've worked with for years, and a lot of which we consume ourselves.

To put that 26 acres or so into perspective, last year, we sold close to 250,000 pounds of cannabis into the bulk market, much of which -- about half of which was harvested from our own material and the other half was sourced material that we ran through our trading house.

We do have another 22 acres in permitting here in Carpinteria, California, which is where our headquarters is. And yeah, I think the reason why Tristan moved the business down here from Humboldt about five years ago was for the opportunity. There were large established sophisticated greenhouses here in Carpinteria that were ready to be converted from cut flowers into cannabis.

So there is a little bit more of a turnkey opportunity to scale up into larger cultivation assets. And even more high-level, greenhouse is really the cultivation medium or method that we believe will be the winning method in the long run. If you look at the cultivation landscape, there's really three buckets of cultivation techniques. There's outdoor, greenhouse and indoor. And there's several -- there's dozens of iterations of sort of sub buckets in between those, but we feel that the greenhouse medium, growing medium or growing method provides the most -- the highest quality for the lowest production cost.

You really can achieve near indoor quality for near outdoor cost of production. And so that's what we believe will be the winning -- will take up the lion's share of cultivation production over the coming decades. Beyond that, I tried to remember your next piece, I think it was about being self-funded, correct?

RS: Yeah, yeah. Let me -- before you get to that, I just want to -- about - your point about that you have a percentage going towards your own consumption. By that you mean your own brand, you're not, it’s not for your guys to consume on your own, right? I just want to clarify that point.

NB: Of course, yeah, yeah, yeah, of course. So I think to clarify, we harvest anywhere between 70,000 to 100,000 pounds of flower a year from our internal production, and that does not include biomass like trim. And then, of course, we source and trade another similar amount of third-party product as well. And then our brand, Mr. Zips consumes a portion of our internal production.

RS: Gotcha. Appreciate it. Yeah, I'd love to hear what you have to say about the outside capital.

NB: Yeah. So with regard to outside capital, talk about a difficult industry to operate in without any outside capital, but talk about also an industry that's difficult to raise capital in, right? And I think when we approach fundraising and capital, whether it be debt or equity, it's all about timing.

You really want to time your raise based of not just the position of your company and what initiatives you have in front of you to execute on, but what - where the market is, what's the price of debt? How is the competitive landscape right now? Is there an outsized opportunity if you have a capital moat, as we call it, disposable funds to execute on strategic initiatives.

But I think our baseline approach, right, our first step in how we, I should say our bias as we approach outside capital is actually to not need outside capital. If we -- we take immense pride at our ability to operate and I think that our ability to not just survive, but thrive for the last two years of volatility in the California bulk market, cannabis market is a testament to our ability to just be prudent and strategic operators.

So right now how we view -- approaching -- why right now we're interested in raising capital is we feel our business is stronger than it ever has been before. The volatility in the market was really a forcing function to -- for us to become leaner and more ops efficient business.

And right now, as many - I've heard many people discuss on your podcast, many operators are struggling in, in the state at the moment. So there is a significant amount of white space and consolidation opportunities, where if we had some capital, we could accelerate our pursuit of those.

RS: Yeah, it's definitely a tough time to be looking for capital. Certainly, there's never really an easy time in this sector it seems, but definitely one of the hardest it seems. So speaking to that point, the difficulty of maintaining your place, growing your space, scaling the space, and the brand and the grow, all while the price of cannabis is seriously fluctuating and that has a big impact.

I'd be interested to hear your thoughts and how you think about the notion of the wholesale market and what that looks like. And also the relationship between price and plan and what -- how that impacts your business model and how you think about the marketplace. Obviously, specifically in California, but if you have any thoughts on how it looks or how it works outside of California, also happy to hear your thoughts there.

NB: Yeah. So I think to sort of frame this for the listeners, the amount of volatility - to frame the magnitude of the volatility, we've seen the price compression over the last two years. Q1 2021, we were – basically, from Q1 2021 to Q3 or Q4, the bulk price of our flower dropped by 60% to 70% in just a six- to nine-month span.

And it really continued to drop precipitously to roughly 75% -- 70% to 80%, or I should say, 20% to 30% of that Q1 2021 number. It continued to shrink down that low, just about until the last three months. And over the last three months, we've seen prices rebound by more than double across the Board.

So, how we view that, obviously, times are good, relatively speaking right now if you're a bulk wholesaler, like we are. But we know that is not the -- being a bulk wholesaler provides you optionality, but it also leaves you vulnerable. And so we view the brand and moving close to the consumer and converting as much of our production into consumer products as a way to really just derisk our future revenue and reduce volatility as that market is a little bit less volatile.

I think that in terms of the cost of the price of flower versus the cost of production, it's going to balance out all markets do. I think that the state removing Cultivation Tax last year was a major win and hopefully that remains a permanent thing. But I think that until there are more retail outlets accessible in California, the market is going to be under tremendous pressure, price compression.

And that said, I think there's only a handful of cultivators in the state that have proven their ability to still operate profitably, even in the worst of the lows of the market, and those that have proven that ability have been able to continue expanding and growing are the ones that are going to come out successful in winning out of the State of California.

RS: So speaking to the wholesale and the retail picture, what is your plan going forward and maybe bigger picture in terms of your own brand and how you're looking to the retail space with that?

NB: Right now, we are actually more profitable selling material into the bulk market than we are selling into the branded market. That said, we are not taking our foot off the gas pedal, with our – with putting material into the brand because as mentioned earlier, the entire strategy behind the brand is to hedge against price volatility. And really, we want the brand to be consuming 50%, if not 100% of our entire internal production, so that our future cash flows are more predictable.

Additionally, moving closer to the customer in the form of branded products, we feel to be more marketable to investors and more relatable to investors as well. And it provides us additional sort of optionality downstream from our margin capture whether through a D2C play or potential consolidation with retail.

RS: And in terms of retail being set, you spoke to the notion of there's just such a limited number of stores opening California , even though if you're in some areas, you would be hard pressed to believe that, but promise, it's true. And we've had many people, Hirsh Jain prominently among them speaking about that on the podcast.

The other notion that seems limiting to the retail picture is if you don't own the space that it's difficult to get your products on the shelf, difficult to turn a profit. How are you thinking about that picture? And also what are your -- are you focused on number of storefronts that you want your product in a year? Are you thinking about numbers? Or are you still working out the bigger picture in terms of D2C and how it's going to look?

NB: Yeah. We are – we view consolidation with retail as really, I think, a means to an end. It's a way to -- I've used the term derisking cash flow, and that's really the name of the game in the industry. You look back to my time at Eaze, and that's a big reason why Eaze decided to go vertical and start touching the plant, so to speak. Eaze was just a technology company until it started actually owning the licenses, out of which, Eaze Delivery operated.

And that's because the only guaranteed cash flow in this industry is from the customer. The customer pays cash or debit card every time when they buy a product. And so by consolidating with retail, it's not just ability to capture margin, it's really even effort to further derisk cash flow.

But when we think about growing the brand, we are doing so not from a shooting for - until we can’t consolidate with retail or until we find the right opportunity. Right now, we are really focused on growing the brand and not with a shooting from the hip mentality, despite us having an exorbitant amount of product that we want to convert into branded product.

Despite that fact we're not shooting from the hip. We're trying to be very strategic, and establish deep relationships with strategic retailers, where we can be a dominant brand on their shelf and build a significant level of trust where we know the retailer is going to pay us on time every time.

I think in short, not all retail markets and not all retailers are created equal. So we really don't have any interest in claiming we're in 400 or 600 doors in California. We really care more about what is our overall top line and what is our profitability of the branded business.

RS: And are you only going to be focused on certain form factors, certain product lines?

NB: So today, we are in flower, pre-rolls and vapes. And flowers and -- flower and pre-rolls are certainly our number one priority as it's directly adjacent or tangential to our core business, which is cultivation. It doesn't require sophisticated manufacturing per se to achieve those and between flower and pre-rolls, that is - those two categories combined do make up the majority of the market.

And so those are the two categories we are focused on. Vaporizers, I'd say coming third, and those are something that we're starting to make headway in. We're in the early stages of our product development today. But yeah, I'd say flower, number one; pre-rolls, two; vapes, three.

RS: I'm curious what led you -- I know that this is maybe backtracking a little bit, but speaking to the plan and the strategy that you have with Headwaters and really some salient pivots that you're talking about, what led you to work with Headwaters? What attracted you to working with them aside from just wanting to get into cultivation?

NB: Yeah. So one aspect that really, really attracted me was the fact that the business was bootstrapped. Yet when I joined in 2021, we did nine figures of revenue, right? So Tristan, with his partners, grew this business from nothing to nine figures of revenue with no outside capital and I found that extremely inspiring.

I do have an aspiration of potentially starting my own business someday. And this was an opportunity for me to join a business as with direct exposure, reporting directly to the two owners of the business, and learning firsthand what it means to run a business where you are solely dependent on your cash flow, and not dependent on third-party investors to keep you alive.

So I think that's what really drew me to Headwaters from a personal development perspective, and that's from a competitive advantage and landscape perspective. Headwaters is one of the largest cultivators in California, one of the most well-known and respected cultivators in California. As we look out towards the, I'd say the next 3, 5, 10, 20 years, I think in the long run, I do think California-grown cannabis will drive a premium.

And so, Headwaters is extremely well-positioned to maintain a leading share, leading position in the California cultivation landscape and capitalize on that potential international opportunity. But then looking more specifically at the business, we do -- we feel that we have a very compelling IP-moat, basically repertoire of IP across genetics, SOP, production SOPs, as well as technology. And let me kind of drill into each of those specifically.

One from a genetics perspective, there are many breeders out there, but most breeders are breeding for an indoor setting. And they're breeding for hype. They're breeding for marketability of the flower. Not many breeders or genetics -- pheno hunters out there are hunting for genetics that not just exhibit high marketability, but also very strong defensible agronomic properties, particularly in a sun-grown environment. So that is rare. And I think that's really been the key behind our nursery business. And that's also what has been the backbone behind our internal production as well.

The second bucket of IP I mentioned was just production SOPs, everything from plant architecture to IPM, fertilization, climate, do post-production processing, labor management as well.

So our IP was already extremely strong. But over the last year-and-a-half through the volatility in the market, it's forced us to be unimaginably scrappy with everything. And I think that's put us -- without sacrificing quality, mind you. So I think that put us in an advantageous position.

And then the last component is technology. So we've developed a proprietary technology in-house called cultivation grid. It's really the birth child of one of Tristan's partners, Neil Gibbons, who joined the business a handful of years ago, and brought his background in the capital markets and data management world to build an in-house, really what is a highly intelligent, comprehensive, almost an ERP system for large-scale cultivation.

And it doesn't apply only to cannabis. It can apply to any large-scale agricultural industry. And what it allows us to do is manage everything from nursery through cultivation through post-harvest processing, all from a bird's eye view across however many cultivation assets we have, it includes scouting, intelligent forecasting, climate monitoring. Really, it's the most comprehensive cultivation management software that we've seen in the market, and has been highly sought after not just by MSOs and internal -- and operators specific to cannabis, but even agriculture -- agriculture operators outside of the industry.

And so that's also been a huge key behind, I think, our ability to maintain consistent quality and high efficiency with an extremely lean team. And frankly, it is a high upside unexercised option really on our balance sheet, speaking to potential SaaS opportunities that we've just kept close to the chest because we believe it gives us such a strategic advantage relative -- or competitive advantage relative to the market.

RS: I was going to ask in terms of the proprietary technology specifically and that patentability, does that help in terms of how you're thinking about scaling? Does it help in terms of raising capital? How is it most beneficial to you?

NB: Yeah. So I think first, as the market -- first is internal production, right? As the market has compressed, it's become and there's been much less breathing room for mistakes, it's allowed us to be highly data-driven with everything that we do in this business. No, we are not -- most operators depend on their head grower to give anecdotal evidence and direction based off their own experience growing in that greenhouse. Now, we have data to prove and backup really every decision we make across the entire plant lifecycle.

Everything from, obviously, flower time to IPM support architecture, we can run experiments. We can even monitor our labor force for efficiencies to see where are there potential units in our labor force that could be more optimized. So I think internal production has just given us such an advantage and an ability to really feel confident about the decisions we're making in a highly competitive, very thin margin environment over the last two years.

Beyond that, I think it really, as we look kind of broader picture and sort of what does an end game look like here, if there is an end game for us, we feel that the software would give any large-scale multi-geographical operator an advantage. It's frankly, pretty astounding to us that many MSOs operate cultivation assets across 5, 10 or more states, likely without a single interface for them to manage across the Board.

Many MSO -- we feel every MSO should be -- know exactly over the next three to six months what is their cultivation forecast - what's their harvest forecast look like? And how does that translate into cash flow? And so it's pretty astounding for us that no one has comprehensive solution out there and we feel it's a pretty plug and play, the turnkey solution that would immediately improve a large cultivation operation.

And then I think the longer, long, long-term plays if we don't have an end game of potential exit and we continue to operate the business, which we're prepared to do into perpetuity is, yeah, it gives us optionality. It allows us to - without investing hard capital into cultivation assets and other geographies, it allows us to essentially license out our IP to other geographies and provide management services to establish -- to not just demonstrate our ability to expand and scale with a lean team, but to also potentially as a foray into potential other licensing opportunities, like genetics.

RS: Does that get -- I mean, I know it's all the same type of business. It's not like you're trying to figure out something beyond cannabis. This all speaks to growing cannabis in different points of revenue. But does it get -- or do you feel that there's a risk to it getting too many points of focus? And that it takes away from a couple of points of revenue generation. Does that worry you at all?

NB: Yeah, just to clarify, you're saying if we were to put effort behind trying to license out the technology, what are the risks, right? What's the opportunity cost?

RS: Yeah. Or just like focusing on licensing out that software, does that take away from the retail opportunity? Or does the retail opportunity or the retail focus take away from the software? I say it mostly because I've seen different companies that have done that and it's not in the exact same way you're talking about. There were some real different areas of focus, and I don't know that any of these are that different. But I think the point is there.

NB: Yeah, look, I think it's a fair question, all right? And earlier when we discussed going through -- going after retail, I really framed that pursuit or that interest as a means to an end, a way for us to derisk our cash flow while gaining margin along the way. But that's not our core purpose or mission. We are really cultivators at heart. We are not branders. We don't have retail management staff on, on staff at all.

So I do think that yeah, our preference and what we feel is more of a unique and compelling story to tell in the broad - in the broad story of cannabis as a single operator is really being a specialist in large-scale cultivation and using our technology to -- or leveraging our technology to demonstrate that, right? So I agree with you, Rena. I think that we're only -- as mentioned, we're a lean team. We can't focus on everything all at once. And so right now, we're just trying to keep our heads down, continue developing our IP, executing on the task at hand and really take opportunities as they arise and be opportunistic with it.

RS: I think speaking to the notion of surviving and how you best do that, it's a topic that's definitely been brought up by a number of different people on this podcast in terms of it's a burgeoning industry. And as I get more into understanding the psychedelic side of healthcare, that's also definitely a burgeoning part of the industry where companies are looking at, “Okay, how do we maintain revenue and get closer to profitability, while the environment looks pretty stinky. ” And okay, this is a way to do that.

So I definitely think that's part of the survivability. And speaking to the consolidation that many people see is happening right now, many people see more coming. And I think it's obvious that there's going to definitely be less players in the landscape as the months and years develop. When you look at the landscape, are there -- is there a short list of partners that you would have? Is that an ever-evolving conversation? How do you think about that as the environment continues to develop?

NB: And partner specifically in the retail sector, is that right?

RS: In the retail sector licensing out your software, or is that just something that you would license out to people that are willing to pay the price for it?

NB: Yeah, it's a good question. Short answer is no. We are highly selective. And just in the two years I've been here, I can tell you, there's probably been a dozen different M&A opportunities that have crossed my desk here in – at Headwaters, and we haven't pulled the trigger on any of them really.

There's a few items that we really are focused on when we look at strategic partners. One is mentality. How do they approach running their business? Are they -- is their head in the sky and they still think that the sky's the limit? It's all about growth and just – and they're not too concerned with cash flow? Or are they extremely prudent operators who really know what it means to run a business without leaning on outside capital, right?

I think there's few and far between. And staying with that few and far between theme that, hey, there's so many operators out there who are looking at immense amount of debt on their balance sheet that they don't know what they're going to do with, or they're in the process of negotiating payment plans for. Many of the deals that we've been approached with are businesses that are looking at a large amount of debt and looking to Headwaters to effectively save the day and we don't really have any interest in that.

We are only interested in combining with businesses that would be mutually accretive for both of these. And to that point as well, directly complementary and synergistic, not duplicative, right? So that's how we look at partnerships. I think the other item here too is we're really laser-focused on California. We do have relationships around the country and in some other nations as well. But we're laser-focused on executing in California and investing in assets in California, as we believe that that is still the crown jewel, certainly from a cultivation perspective in the long run.

RS: Your point about -- that companies are coming to you and looking to kind of work off their debt somehow, I'm sure that you look at the landscape and see a lot of distressed assets, let's say who have no other partner than another distressed asset. How do you see California shaking out, shaping up maybe in the coming year?

NB: A really good question. And please take my opinion as a grain of salt, because I think it's anyone's guess. So, I think there's a few dynamics at play right now that's going to be extremely interesting.

The first is that the estimates are there's anywhere between 25% to 40% of canopy that was planted in 2022 in California, 2021 through the early part 2022, that is no longer planted or completely with the license -- or with the licenses completely expired as we entered 2023.

So how that translates, there was already an oversupply. I don't think there will be a shortage of material at all. But how that translates into pricing, there will be -- we've already seen a more than 2x increase in bulk pricing over the last two to three months. We think that's going to continue to go up before it goes down. And we think we are hopeful. But we do believe we have confidence that the floor whenever we see it again, it won't be as low as what we saw over the last year-and-a-half. What that means for operators downstream in the value chain and for consumers is any brand that does not own their own cultivation production, I think, is going to have a very, very challenging time surviving over the coming year.

And so we've already seen -- if you look at the headset data for Q1, you already see depending on the category, roughly 25% to 50% fewer brands being sold through California retail according to Headset than there were six to eight months prior, right? So I think that's happening, it's starting and you're already - and it's going to accelerate which will mean consolidation opportunities on the shelf.

In terms of pricing, I think that if you also look at the overall market and you look at the top line for the California retail market, a lot of estimates show slight shrinkage in 2022, while volume has actually stayed flat. That's so which means the shrinkage is entirely due to price compression. Because we have seen a major rebound in bulk pricing, we're very hopeful that that will lead to stabilization of prices at the retail level and therefore growth as we move forward.

Now that can be completely sabotaged by the next dynamic that's at play right now as we speak. Actually, this week, in fact, which is -- there is a rule of change in California - in the California market this year that went into effect. Prior to 2023, it was the distributor’s responsibility to collect all excise tax for products sold to retailers and then to remit that excise tax to the state.

Starting in 2023, that responsibility has now shifted to the retailer. So now the retailer does not remit excise tax to the distributor, they actually remit the excise tax directly to the state on a quarterly basis.

Now retailers have already been quite notorious in California for not being good at paying their bills and with cash flow management. And while this initially may actually seem like giving them an advantage, which really it should, because it gives them two to three months of excise tax accrual that they can use to help manage their cash flow, before having to remit it on a quarterly basis to the state.

I think there's very -- there's quite a bit of skepticism in the market that retailers will be able to actually -- have managed their finances accordingly and their future cash flows accordingly, and will actually be able to successfully remit that to the state.

What the impact that has on the retailers has yet to be seen. It's really unknown how the state is going to react. I don't think it's an option for the state to completely rescind retail licenses based off the immense amount of uproar over the last couple of years about the shortage of retail licenses.

But it certainly could lead to even more retailers being distressed and potentially some going out of business, right? So that's what I think we're going to see, I think we're going to see a lot more, and you're going to see fewer brands on the shelves, and then we're going to see price stability on the shelf, maybe not price increase, but certainly price stability.

I think we're going to see a lot of retailers either going out of business or changing hands. And then I think that frankly on upstream, I think that distributors and brands that don't have extremely diligent collection management practices are going to be at risk as well.

RS: Yeah, definitely sounds like some sober perspectives. So -- and thank you for that insight into the new law, I hadn't heard that. In terms of how you're looking at the coming year in terms of Glass House ( GLASF ) and the illicit market, two things that many people have been on this space saying are huge things to think about in the California market , how are you looking at those two, I guess, points when you think about scaling in California?

NB: Yeah. They're really good questions. And we are - we see - Glass House is one of our closest and most trusted partners. We are huge fans of theirs and really excited to see them continue to expand their cultivation footprint. They are one of our largest partners from a genetics perspective. We work very closely with them. So their success hopefully means our success as well, and so we're excited for that.

As it pertains to the illicit market, we -- the illicit market, obviously, nationwide and around the world has historically had high demand for California cannabis. And as more states have come online, you've seen some of that - you hear about some of that demand falling.

And so - but that said, I think that what the illicit market does demonstrate is how high that demand is for California cannabis, because what we hear these things through the grapevine and we don't see them firsthand, but we know that it has an impact on every operator in California, whether you're a retailer, cultivator or something in between. And despite these other states coming online, we haven't seen it impact, our dynamics at play here nearly as much as the license imbalance has been in the state between cultivators and retailers.

So the illicit market, I think, it's a very difficult topic to break down and to diagnose. Because there's just so many factors at play, most of which is done in the shadows, right? We don't have established, published data that's trustworthy on it, and I think everyone has their own opinion.

RS: Yeah. And in terms of Glass House, do you see other competitors in terms of companies and also just to kind of clarify or unpack your point about if Glass House does well than you do well. Would you say that it's a different scale of what they're doing and you have their proprietary technology also at your disposal that kind of differentiates you, but the fact that -- look, there's going to be a lot of cannabis grown and sold in California and beyond and so, there's space for both?

NB: Yeah. Yeah, we think there is space for both. And there are other competitors out there certainly that we do look at many of which are neighbors here in Santa Barbara County.

But Glass House, we feel from a purely a footprint perspective or largely a footprint perspective is our largest competitor.

We do think that we are somewhat differentiated. We do feel that we have a lower cost of production and a differentiating technology, as well as a richer sort of repertoire of proven genetics for sun grown environments. And so yeah, across those three IP buckets that I discussed earlier, I do think it gives us somewhat of an advantage.

We are not too concerned about the flood of material from them into the market, because we participate, we help them with that off -- with that wholesale distribution aspect, which gives us certainly an incredible picture into the market, allow us to stay really close with Glass House and grow with them over time.

So we really do view them as a synergistic partner, where we can both -- there is a win-win scenario that we are currently enjoying. And there is not -- we don't view that relationship, and certainly as a -- there has to be a winner or loser or substitution, we think we can both win together.

RS: Gotcha. I think there's been many points of light for retail investors to read between the lines of what you said, and some you said outright. I love it if you shared how you would synthesize retail investors who are looking at the space, how you would synthesize your thoughts there, and maybe timelines or points or places of the marketplace that they might focus on?

NB: Yeah. Yeah, certainly. And you mean, just in general, looking at the public markets as a whole, not just Glass House or California?

RS: Yeah, exactly.

NB: Yeah, certainly. So, if I'm a retail investor looking at cannabis, I think, the number one piece of advice I'd say is, be wary. And be wary and don't be sold by some vision. You really have to do your homework. And I think that the areas of value that I would pursue if I was a retail investor, are one, first and foremost, form your own thesis on the market.

I think if you look at a Glass House as an example, I do think they have a differentiated asset, right, that in that 125-acre greenhouse - top of the line greenhouse.

So, if you kind of go back to my thesis that I described earlier in the podcast how we feel that here at Headwaters, that greenhouse is going to be the winning cultivation methodology in the long run, and that California cannabis will drive a premium in perpetuity in the international markets, Glass House is extremely well positioned to capitalize on that opportunity in a scenario where there is international trade.

That said I think you could -- let me double up on that. I do think that you can apply that sort of differentiated IP or differentiated positioning to any segment. So if you're looking at -- if you're a big fan of brands, you think brands are going to win in the end, look at a brand that's really created products that have a -- products that they in of themselves are differentiated in the manufacturing of them or products that have a brand that have become a ubiquitous leader in their category.

I think CANN is a great example in the beverage space. I think Papa & Barkley is a great example as well in the sort of more medicinal applications for extracts. And I recognize that neither of those are public companies, but they are very, very well known in the cannabis California market, and really in the national market as well. So looking for opportunities like that.

The second aspect is assets. Well, I certainly would not say I'm a general fan of the land grab strategy that you name it, many MSOs have deployed, trying to just scoop up assets across retail and cultivation wherever they can. I do think that retail specifically is going to be a license type that will retain value in limited license markets for a very long time.

So public companies that have accumulated retail assets in limited licensed states that have high upside, a large market are certainly areas I would look to. But I don't place any value at all in cultivation or production capabilities of these MSOs, only really in their retail assets.

And the last piece in talking about doing your homework is after you form a thesis, and then you kind of narrow down which segments of the market, which types of operators that really you believe in the long-term strategy and trajectory of, then you have to look at their finances and look at their debt load, look at their cash flow. And many of these operators have cash flows, that cash flow to debt ratios that mean that they're not going to be able to pay back their debt for decades when most of their debt facilities are coming due in a much shorter period of time.

So those are really the three elements is form your own thesis, look for companies that are -- form your thesis for companies that are well-positioned based off that thesis and then really qualify those opportunities based off the finances of the business.

RS: Good stuff, Nick. Good stuff. Well, I really appreciate it. I appreciate seeing you in person and getting to see Headwaters canopy and all the stuff that you have going on there. Appreciate the deep dive today, and look forward to our next conversation.

NB: Definitely, Rena, anytime. It's my pleasure.

For further details see:

Cultivating Profitable Cannabis