GLASF - Glass House Brands Inc. (GLASF) Q1 2023 Earnings Call Transcript

2023-05-16 00:02:03 ET

Glass House Brands Inc. (GLASF)

Q1 2023 Earnings Conference Call

May 15, 2023, 5:00 PM ET

Company Participants

John Brebeck - Vice President, Investor Relations

Kyle Kazan - Co-Founder, Chairman and CEO

Mark Vendetti - Chief Financial Officer

Graham Farrar - Co-Founder and President

Conference Call Participants

Bobby Burleson - Canaccord

Scott Fortune - ROTH MKM

Jesse Redmond - Water Tower Research

Howard Penney - Hedgeye

Mike Regan - Excelsior Equities

Presentation

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Glass House Brands’ First Quarter 2023 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

Thank you, Jenny. I’d like to welcome everyone to the Glass House Brands’ first quarter 2023 conference call for the three-month period ending March 31, 2023.

Listeners are reminded that certain matters discussed in today’s conference call or answers that may be given to the questions asked 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 like to remind everyone that this call is being recorded today, Monday, May 15, 2023.

And I would now like to introduce Mr. Kyle Kazan, Co-Founder, Chairman and Chief Executive Officer of Glass House Brands. Hey, Kyle, over to you.

Kyle Kazan

Thank you, John. Good afternoon, everyone, and thank you for joining us for today’s call. In the first quarter of this year, we are free cash flow positive operations, one quarter ahead of schedule. This has been our goal since we purchased our first farm at Casitas in Santa Barbara and I can’t emphasize enough what an important achievement this is to Graham and me, and of course, to our entire Glass House family.

So much so, in fact, that I am honored to be the one to announce this publicly. This achievement would not have been possible without the loyalty, confidence and support of our shareholders, including those of you who trust us with your money in the early days, of private equity partnerships all the way up [Technical Difficulty]

Those who invested in us as a public company, and of course, our debt providers who took a chance in a fledgling cannabis company with a unicorn asset or SoCal farm. This quarter’s performance signals that we have crossed a critical threshold in our operations, one that will hopefully lead to increasingly stronger cash flow generation in the months and in the years ahead.

To put this all in context, California is the largest, most well-educated cannabis market in the world with the most discerning consumers and is a recognized home of cannabis. We have long felt that the hard work it would take to succeed in such a competitive and challenging market would be worth to pay off and now we are closer than ever before. While much hard work lays ahead we feel like we have just opened the door to even greater opportunities and that’s the best lies ahead.

To booth, this was accomplished with unique challenges that no other industry has ever faced in the United States, federal provision to ADE, making many expenses non-deductible, vastly more expensive fundraising in both equity and debt, and the wild swings of an industry in the largest and most competitive market in the United States, a market which has caused many to question whether it is worth competing in. To us, the answer has been a resounding yes.

None of this would have been possible without our amazing team at Glass House Brands. So I’d like to give a special shout out to my teammates. Thank you for your continued hard work and commitment to excellence.

Our business momentum has remained very strong in 2023 and we hit several major milestones in the first quarter that bolster our confidence in the outlook for 2023 and even more for the longer term.

In the first quarter of 2023, we exceeded our production, revenue and margin guidance, and narrowed our adjusted EBITDA loss to $149,000 versus a $2.6 million loss in the fourth quarter and we did all this at a time when industry conditions and the overall macroeconomic environment were and remain incredibly challenging.

Collectively, our performance in the first quarter of 2023 continues to demonstrate that our unique business model has significant competitive advantages that we are just beginning to unlock, which will lead to tremendous growth in future revenues and profitability along with driving sustainable value for shareholders.

Our entire team has been energized by our recent decision to retrofit and begin operations at a second Glass House on our SoCal farm. It will accelerate our growth trajectory and have a significantly positive impact on long-term profitability along with further solidifying our strong competitive position.

When you combine our attainment of positive free cash flow with the powerful cash flow generation potential we are now unlocking in our SoCal farm. You can see the power of our financial flywheel starting to take hold.

As I shared with you on the fourth quarter earnings call, we have yet been our first anniversary of harvest and sale of SoCal farm cultivation and less than 20% of capacity is currently growing cannabis, yet we are already generating cash on cash rates of return in excess of 20%.

The Phase 2 expansion will cost an estimated $10 million and will enable us to increase biomass production by approximately 250,000 pounds annually or by 80% when fully utilized. This translates into $72.5 million of incremental revenue annually and over $31 million of gross profit if we simply use our average selling price and margin figures from the first quarter, which we believe are conservative.

Making the SoCal farm the sole focus of our future growth is deeply rooted in our disciplined capital allocation strategy. When you think about the powerful underlying economics of the SoCal farm, there are a few other investment opportunities that offer such a high potential risk-adjusted rate of return, certainly not in the cannabis space and I would contend the same is true relative to opportunities across the broader investment landscape today.

It would be irresponsible of us as managers and owners. Remember, our interests are aligned with our shareholders as we are also significant owners of Glass House Brands equity just like you to not put the Southern Cal farm as a top investment priority for the foreseeable future.

Other factors that support the timing of our Phase 2 expansion include the current environment of favorable supply/demand dynamics and our proven operational expertise. The continued uptrend in cannabis pricing is a key indicator that supply/demand conditions are strong in the favor of cost-competitive producers such as Glass House.

Moreover, given the high probability of additional capacity falling out of the market, there is clearly a tailwind in favor -- in our favor since we have the lowest cost production and a long runway expansion of massive scale ahead of us.

In terms of operational expertise, only -- one only needs to look at our consolidated wholesale biomass gross margins. Our consolidated gross margin has improved from 17% in the first quarter last year before the booking of any costs from our SoCal farm to over 40% in the first quarter this year. Our wholesale biomass gross margin went from negative 8% in the first quarter of 2022 to positive 43% in the first quarter of this year.

While we were always confident that we have proved to be one of the strongest operators in the industry, the pace and trajectory of our margin improvement over the past three quarters to four quarters has surpassed even our initial expectations and we are just getting started.

To recap, Phase 2 of our SoCal farm expansion is expected cost of approximately $10 million, we will increase our current capacity by 80% and should produce over $30 million of gross profit annually.

Phase 1 and Phase 2 together should be able to generate annual revenue of more than $150 million at full capacity and adjusted EBITDA margins in excess of 30%, which we expect to enable us to fund future rounds of investment in the SoCal farm with internally generated cash flow and drive even higher rates of return, accelerating our production and financial flywheel by growing more amazing cannabis, which will drive value for shareholders.

It should be noted that after we complete and turn on the latest expansion, we will only be utilizing approximately 40% of our SoCal facility, leaving considerably more room for further expansion of our cash flow generation capability.

I will now move on to the highlights from our first quarter operating performance. We had another solid quarter at our SoCal farm and our total production increased 188% year-over-year to over 48,000 pounds of wholesale biomass, which was ahead of our guidance. As a reminder, the first quarter is a seasonal low point, which is why our production was down from the fourth quarter as we anticipated.

Given the difficult weather conditions during this period, we are very pleased with our performance and it heightens our level of confidence in achieving our production guidance for the year. Additionally, the higher-than-expected pricing trends in the first quarter provide us with optimism on the pricing outlook for the rest of the year.

I am very pleased with our first quarter results, including total revenue of $29 million, which was up 108% versus last year, and above the top end of our guidance with all three of our lines of business delivering year-over-year growth. Wholesale revenues increased by over 180% and accounted for the majority of the year-over-year increase, reflecting higher production as well as improved pricing.

Average selling price for wholesale biomass was $290 in the first quarter, up 54% versus last year and up 23% compared to the fourth quarter. Retail revenue nearly doubled driven by unit growth, including the pharmacy locations we opened in Isla Vista in late December and Santa Ynez in January.

Gross margin was again a major positive and provides a strong indicator of our future profitability and free cash flow generation potential. Our consolidated gross margin of 41% was up from 17% a year ago and 9 percentage points above the fourth quarter.

And similar to revenues, we drove year-over-year improvement in gross margin in each of our business segments. Wholesale gross margin was in line with the fourth quarter despite the seasonal drop in volume and was aided by improved pricing and year-over-year reduction in production costs as we further optimize performance at our SoCal farm.

Our retail gross margin benefited from the shift in excise tax collection and the strong recovery in CPG gross margin reflected our disciplined approach to managing this business in what continues to be a challenging operating environment.

We are optimistic about future pricing trends based on the latest results in our business, as well as what we are seeing across the industry in California relative to capacity and licensing renewals.

We estimate that from June 2022 through the end of April, licensed California cultivation capacity has fallen by more than 16 million square feet of canopy representing about a 21% reduction in acreage under cultivation, which is about 4 times the fully built-out capacity of our SoCal farm.

For additional perspective, 16 million square feet is roughly 17 times the size of our existing cultivation canopy of 959,000 square feet, which partially explains why our wholesale business, biomass finished goods inventory level has consistently remained about one week since the beginning of the year, 523 cultivation licenses are up for renewal in May and another 1,075 in June meaning that one in four active licenses in California are up for renewal in the next 60 days.

An underappreciated fact is that as of January 1, 2023, provisional cultivation licenses cannot be renewed for operators that have a total canopy exceeding 22,000 square feet. Almost 50% of all outstanding licenses are provisional, which we estimate is roughly 30 million square feet of cultivation. By the end of this year, many of these licenses will need to be converted to annual licenses, which have higher hurdles than provisional license.

One of these being the need to meet CEQA requirements. For those outside of California, who have never heard of CEQA or its formal name the California Environmental Quality Act is a major hurdle to development, given the expense reporting and vulnerability to challenges of the individual projects in court. It is our understanding that many of these provisional license holders will have a difficult path to qualify.

In Monterey County, for example, only about 10% of the farms had converted as of the end of March and in Mendocino County, only 1.5% had converted. This is not an issue for Glass House. All of our licenses have made the challenging transition of fully converted to annual.

In summary, we continue to execute well against our strategic priorities in the first quarter of this year, driving significant growth and hitting several key profitability milestones, including reaching positive free cash flow and nearly achieving breakeven adjusted EBITDA, a full quarter earlier than expected. We are consistently demonstrating the durable competitive advantage of our very integrated model.

Before I hand over to Mark, I’d like to once again extend a warm invitation to all shareholders to join Glass House Brands’ Investor Sesh 2023, where investors can tour our unicorn greenhouse facility ask questions directly to Graham and me, along with the rest of our talent at C-Suite and join our Annual General Shareholder Meeting.

There will be exclusive merchandise and Glass House Brands products, food and Investor Relations booth. I look forward to personally welcoming our shareholders to the event again this year. It will be held on Friday, June 23, from 9 a.m. to 4 p.m. Pacific Time.

Transparency is a key part of our name and our culture, which is reflected by our desire to personally meet and provide tours to anyone amongst our loyal investor base. Please join us in Southern California, if you can.

With that, I will turn the call over to Mark Vendetti, our Chief Financial Officer, to discuss our financial results for the quarter in detail, following which Co-Founder and President, Graham Farrar, Mark and I will take your questions. Mark? I am not hearing Mark on the call.

Mark Vendetti

Apologize for that. Thanks, Kyle, and good afternoon, everyone. As a reminder, the results I am sharing will be filed today. They can be found in our financial statements and MD&A, which are reported in U.S. dollars and prepared in U.S. GAAP.

Total revenue for the first quarter of 2023 was $29 million at the high end of our Q1 guidance of $27 million to $29 million. This represents 108% growth versus last year, driven by strong gains in all three segments.

Wholesale biomass revenues of $14.5 million were up 182% year-on-year and down 7% quarter-on-quarter, reflecting the normal seasonality of our business. We produced 48,000 pounds and sold nearly 50,000 pounds in the first quarter, up 188% and 179%, respectively, from the same period last year.

Price per pound blended across flower, smalls and trim reached $290 per pound, which was above our guidance of $2.75 and was up 54% versus a year ago and up 23% compared to the fourth quarter.

As a reminder, the cultivation tax was eliminated effective July 1, 2022, for ease of comparison and to ensure consistency, we have removed the impact of cultivation tax on both revenue and cost of sales from prior periods.

Moving on to the California market. Data from headset shows the retail environment for the California market remained challenging in the first quarter, with total market sales down 8% versus Q1 last year.

Flower sales declined 17% year-on-year, while pre-rolls substantially outperformed the market rising 4%. Flower plus pre-rolls combined were down 11% year-over-year in Q1. Vape and edibles were both flat year-over-year continuing to outperform the overall market. And on a sequential basis, overall, California market sales 4% -- fell 4% Q1. In addition to challenging industry dynamics, we feel the first quarter continued to be negatively impacted by macro factors, particularly inflation pressure and consumer behavior.

Despite the decline in retail sales, total market demand remained steady, unit volume declined 1% versus Q4 but was up 3% to last year. This is indicative of the extremely competitive CPG market, which has resulted in declining retail prices.

Moving on to retail. For the first quarter, where our total footprint encompasses nine locations under three different banners. We have five pharmacy dispensaries, including three that have been open all of 2022, one in Isla Vista that opened in mid-December and one in Santa Ynez that opened in the first half of January.

Our four other locations include the Pottery dispensary and three natural healing center locations, all of which were acquired during Q3 of last year. For Q2 earnings, our retail footprint will include 10 dispensaries the NHC Turlock store opened in late April.

First quarter retail sales were $9.4 million up 93% year-over-year, primarily reflecting the addition of new retail locations since the first quarter of 2022. Looking forward, 2023 retail sales should continue to show strong year-over-year growth with the contribution of the seven dispensaries we have added since Q3 2022.

Turning to our CPG business. First quarter sales were $5.2 million, up 30% year-on-year and down 13% sequentially. Ahead of our guidance of down 20% sequentially. The retail credit environment continues to be very challenging, but we are able to navigate this better than anticipated.

We expect retail will remain credit challenged for the remainder of the year discounting is still higher than we would like to see, but has remained relatively stable over the past six months and has significantly improved from a year ago.

During Q1, discounts as a percent of gross sales was 21%, up slightly from 19% in Q4, but well below the 42% we experienced in Q1 2022.

Moving to gross margins. We continue to be very pleased with our progress. Consolidated gross margin in the first quarter of 2023 was $12 million or 41% of revenue versus $2.3 million or 17% of revenue in the first quarter of 2022. This is 9 percentage points above Q4 and the highest gross margin percent since Q2 2021, the last quarter before wholesale prices began their large decline. Importantly, gross margin in each of our three business lines showed improvement on a year-over-year basis.

The wholesale biomass gross margin was 43%, matching the Q4 level and the highest since Q2 of 2021 when the average selling price was $3.41 per pound or 18% above first quarter 2023. The increase in average selling price helped to offset the seasonal increase in cost of production, which increased from $127 per pound in Q4 to $196 per pound in Q1. However, this was better than our guidance of $200 and 18% better than Q1 last year.

Retail gross margin in the first quarter was 52%, up 10 percentage points sequentially and 9 percentage points year-over-year. The increase was in line with expectations and driven by the change in collection of excise tax discussed on our last call. Please note the first excise tax payment from retailers was due to the state May 1st.

We made our payment and we will monitor this closely to see how this impacts retailers. This also provided a one-time benefit to our first quarter cash of approximately $1 million as we collected excise tax, but did not have to make the payment within the quarter.

And CPG gross margin was 18%, up 33 percentage point sequentially and up 2 percentage points year-over-year. Recall, our fourth quarter was negatively impacted by several one-time items related to the Plus relaunch and heavy discounting related to the Oswald launch.

In addition, we fully implemented a disciplined sales and operating process that tightly links the sales and production forecast at the item level to ensure we have the right inventory levels and tightly control our aged inventory.

General and admin expenses were $11.4 million for the first quarter, compared to $13.9 million in Q4. The $2.5 million reduction was primarily attributable to a $2 million reduction in stock-based compensation. No new grants were given in the first quarter compared to the fourth quarter, which contains several the year-end adjustments.

We expect this number to increase in subsequent quarters. The remainder is due to a reduction in bad debt expense. In Q4 2022, we incurred bad expense of $0.6 million related to plus receivables from the acquisition.

Sales and marketing expense were $700,000, down 25% year-over-year and 24% sequentially as we continue to be choiceful about where we invest in marketing.

Professional fees were $1.5 million, down 42% year-on-year and down 20% from Q4 2022. We have significantly reduced our reliance on outside legal and consulting resources over the last six months and we will continue to look for areas where we can further reduce our expenses both in professional fees and general and admin expenses. Our plan all along has been to limit growth in SG&A as we increased revenue to improve cash flow and profitability.

Depreciation and amortization in Q1 2023 was $3.8 million, up $0.4 million from Q4 due to the effects of CapEx spending in the fourth quarter of 2022 for both our SoCal Farm and the Isla Vista and Santa Ynez dispensaries.

During the quarter, the company recognized a non-cash impairment expense of $23 million for goodwill and intangible assets related to the CPG unit and Plus edibles. The impairment was triggered by the decline in the outlook for revenue and profit for the CPG unit, which resulted in the fair value of the unit being less than the carrying amount of the business unit. The difference created the impairment charge in the quarter.

At a loss of $149,000, our Q1 adjusted EBITDA was sharply improved from both Q4 and Q1 a year ago, driven by topline growth, higher gross margins and improved management of operating expenses.

We define adjusted EBITDA as earnings before interest, taxes, depreciation and amortization adjusted for transaction costs, restructuring costs, share-based compensation and other non-cash operating costs. Please note the adjusted Q4 EBITDA results include the incremental costs associated with the Plus relaunch and the bad debt expense associated with the Plus acquisition.

We ended the quarter with $16.4 million in cash, including $3 million of restricted cash, which compares to $14.1 million of cash at the end of Q4 2022. We generated $4.5 million of cash from operations in Q1 2023 versus cash usage from operations of $9.3 million in Q4 and $15.5 million in Q1 last year.

In Q1, our cash impact from net income improved to a loss of minus $4.1 million from minus $6.6 million in Q4. In addition, working capital benefited by $5.6 million, because there was no income tax paid in the quarter. Recall, in Q4 2022, we paid our state and federal taxes for fiscal year 2021. In addition, we had favorable working cap broadly within the quarter.

Capital spending was $1.1 million in Q1, compared to $4.1 million in Q4, because the CapEx associated with Isla Vista and Santa Ynez stores were completed in Q4 and the CapEx associated with the SoCal Farm drop to $1 million versus $2.5 million in Q4.

Delivering positive free cash flow one quarter ahead of our guidance was another major achievement in the first quarter, further reflecting the significant improvements we have made to drive scale and enhance profitability.

Now on to our outlook for Q2 and the balance of 2023 based on the strength of the first quarter results and current trends, we remain confident in the direction of our business. We are providing the following guidance for the second quarter.

We expect total revenue to be between $38 million to $40 million, which is a 34% sequential growth from the midpoint and 137% change from Q2 last year. Wholesale revenue will increase in Q2 versus Q1 due to the seasonal increase in production and higher average selling price.

With regards to biomass production, we expect to produce a minimum of 75,000 pounds in Q2, compared to 48,099 pounds in Q1 as a result of normal seasonality. This compares to 25,173 pounds in Q2 last year.

Also note, Q2 of this year will be the last quarter in which the prior year quarter includes only our Casitas and Padaro farms. Recall, we include all flower, smalls and trim in our calculation for pounds produced and pounds sold. In addition, given current wholesale pricing for mid-May, we are projecting the average selling price in Q2 to be approximately $325 per pound, compared to $290 per pound in Q1.

Regarding our consumer touching businesses of retail and CPG, we expect Q2 to be similar to Q1 in revenue. We are assuming the retail environment remains impacted by heavy discounting for brands and that retailers remain credit challenged.

We expect to make continued gross margin improvement in Q2 versus Q1 with total company gross margin percent improving to the mid-40s, up from 41% Q1. We expect improvement in margins to be driven by the higher average selling price in wholesale, as well as a decreasing cost of sales.

Retail and CPG profit margins are forecast to be consistent with Q1 in percentage terms. Cost of production for wholesale biomass is projected at $150 per pound, down from 196 in Q1 and $159 in Q2 last year.

For the quarter, we expect adjusted EBITDA to exceed $5 million in operating cash flow to be similar to Q1. Please note, Q1 had the benefit of collecting excise taxes, but not having to pay them until Q2. That provided about a $1 million benefit in Q1. In addition, the company paid $1 million in semiannual property tax in Q2, which further reduces Q2 cash flow compared to Q1.

We will continue to manage CapEx expenditures conservatively and expect Q2 CapEx to be similar to Q1 at $1 million.

With the close of the Preferred Equity B Series in late Q4 and the closing of the C Series in Q1, our quarterly cash dividend will be $1.375 billion until the end of 2026 or until we pay back the preferred equity.

Looking forward into the second half of 2023 and the full year, I want to first talk about biomass production. We are increasing our production estimates from 310,000 pounds to 315,000 pounds. Recall that when we first provided biomass production guidance for 2023, we started at 275,000 pounds.

At current selling price, the incremental 40,000 pounds equates to over 13 million and incremental revenue and almost $6 million gross margin dollars at our current gross margin percent. Our guidance implies almost 192,000 pounds of biomass production in the second half, an increase of 28% versus the second half of last year.

However, we are increasing our cost of production for the year and second half by $10 per pound. We have raised our guidance for cost per pound in the second half of the year to $1.20 per pound from $1.10. This still represents an 8% decrease from last year.

We are also raising our full year estimates to $140 per pound from under $130. With the improved wholesale pricing, we have increased our emphasis on maximizing production, which is reflected in our increased production estimates.

In parallel, we are working on a number of operational improvements in processing, which we believe have long-term net benefits, which will have a short-term efficiency cost. Until we see those improvements translate into cost savings, we are being slightly more conservative on our full year production costs, but we remain confident in our long-term cost target of $100 per pound.

In addition to our Q2 guidance on operating cash flow and adjusted EBITDA, we expect Q3 and Q4 to have positive operating cash flow and adjusted EBITDA. We are leaving our total revenue guidance of $160 million unchanged. This is a 76% increase from fiscal 2022 with revenue of $91 million. However, we are shifting revenue between our three segments.

We are raising guidance for 2023 wholesale biomass revenue to $100 million from $85 million. This is primarily a result of the rapid increase we are joining in biomass wholesale pricing. We are projecting that our average selling price in Q3 and Q4 compared to our projection of $325 per pound for the second quarter.

During the second half of the year, we expect the increase will be driven entirely by product mix as we expect to sell a higher volume of flower relative to smalls and trim, and we are not assuming any increase in product pricing.

We are reducing our CPG wholesale revenue to $20 million from $25 million, reflecting credit challenged retail landscape, as well as the change in our distribution strategy. We are now shipping to our own stores directly and not through a distributor that took ownership of the product.

As a result, we are no longer booking a sale to the distributor. This should result in a slightly improved margin for our retail stores as they get to buy at cost and exclude the distributor markup.

Also, total gross margin dollars within CPG and retail will not be impactful. This change also gives us greater control over our supply gain as we shorten the distribution channel and time to market for products delivered to our stores.

We are reducing our guidance for retail revenues to $40 million from $50 million, reflecting the intensely competitive retail landscape, heavy discounting of products and the fact that sales at our new stores are not meeting our initial expectations.

Although this is not guidance, we expect the wholesale and retail environment will begin to disrupt the brand landscape in a more meaningful way as the year progresses and we will see more brands leaving the market.

Non-vertically integrated brands are having to deal with rising biomass input costs and all brands are dealing with retailers who are not paying. They are getting squeezed on both cost and incoming cash collection.

Using headset data, we calculate there were 171 less brands with revenue of at least $10,000 per Q1 2023 than in Q3 2022, a reduction of 15%. With this potential up heeled lying ahead in CPG landscape, we remain committed to maintaining a meaningful brand presence both in and out of our stores especially given the advantages of cost, consistency and quality that our vertically integrated model provides.

Finally, none of this guidance includes any impact on revenue, cost or CapEx for the extension of the cultivation capacity we are planning at our SoCal Farm.

And with that, I will turn the call back to Kyle.

Kyle Kazan

Thank you, Mark. I appreciate that. All listeners that have hung in from Mark in my initial comments. Just a couple more small comments and then we will open up to the floor. I would like to take this opportunity to update you on our latest efforts to push for the release of those serving prison time for non-violent cannabis convictions in both state and federal prisons.

Last month, we made the exciting announcement that Luke Scarmazzo had formally joined our Glass House family as Lead Brand Ambassador for Northern California. Recall that Luke was released from Federal Prison in March after serving 15, one-five years of an unjust 22-year sentence for operating a medical cannabis dispensary under California’s Proposition 215, which was passed by voters in 1996.

This release was made possible by years of work by attorneys and passionate advocates, including the Weldon Project and Mission Green, both of which were founded and are led by Weldon Angelos.

Luke is now a partner of Mission Green and plans to dedicate its energy to advocate on behalf of those serving present time for non-violent cannabis convictions in both state and federal prisons and to promote the responsible use of cannabis.

Luke’s personal experience has been restated for his involvement in the cannabis industry has given him a unique perspective on the importance of advocacy and social responsibility. The story is an inspiration to the entire industry and we are thrilled to provide them with the opportunity to quickly rejoin the California cannabis industry. Additionally, I look forward to working together with Weldon and Luke as the Weldon Project and Mission Green strive to gain mass pardons and more enlightened regulatory policies.

The fact that I am finishing in earnings call for a publicly traded company, which drives all of its revenues from the sale of cannabis, while over 2,700 people sit in prison for selling far less than Glass House does, demands action if we truly believe in a fair and just legal system.

I continue to call on President Biden to do the right thing and fully pardon all of those people with the same vigor he used in securing the release of Brittney Griner from Russian jail. It is always the right time to do the right thing.

With that, let me turn it back to the Operator for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question is from Bobby Burleson from Canaccord. Please ask your question.

Bobby Burleson

Hi. Yeah. Thanks for taking my question and congratulations on the strong results. It’s nice to see a cannabis company going in the right direction. I think, probably just to start, can you maybe help us understand what form factors in the brand arena. If we are going into kind of an extinction event for brands where you see the most pressure in terms of form factor, is it edibles, is it some other form factors?

Kyle Kazan

The diff -- so thank you for the call -- the question, Bobby. The difficulty right now is that retailers are under such stress that they are having difficulty just paying their bills. So I might say it’s less about form factor and more about the wherewithal of these companies, all the distributors in the state are distressed and many of the retailers are. So there’s been a bit of a juggle. And let’s also remember that, as Mark mentioned, retailers now carry the burden of the excise tax and so that has also made it so they have to juggle.

So imagine retailers that have perhaps higher-than-normal rents, perhaps some debt that’s out of the ordinarily, it’s high also and now you have got to pay excise tax and the industry is tough, we are highly taxed. So I don’t think it’s like gummies are going out and flowers coming in or something like that. I just think it’s all brands are under significant stress from getting paid.

Bobby Burleson

Fair enough. And then just…

Kyle Kazan

I can add on to that just quickly. I think it’s probably flower, your vapes that are -- and vapes that are going to see the most pressure, edibles probably will see the least. And the reason for that is basically just you are seeing a recovery in biomass prices, so the inputs to those products are getting more expensive.

They were destructively and artificially low for a while there and so you saw -- when you could buy flower for $50 a pound, a lot of people and put brands and quotes here, came in and bought inexpensive.

I would say sub-cost of production for most farmer’s flower, put it in a package and put a sticker on it, we call it a brand, but you had a bunch of those guys who saw a lot of competitive pressure there.

Now the flower is recovering and you are seeing pricing much higher, that margin goes away, so they can’t keep doing that. The other place you will see it is vapes, where distillate was as low as $700 a liter. Now that pricing is even just in the last four months or five months has come up to $2,300 a liter. So the input cost there is literally tripled in the last few months.

And so again, I think, if you don’t have -- we don’t control your supply chain, if you don’t have very low and efficient COGS, that you are going to find yourself priced out of the market, because the -- if our business was based on packaging up sub-cost of production flower, that’s going to go away and you are going to have to have a real business that can run in a sustainable fashion.

Bobby Burleson

Great. Makes a lot of sense. And then just -- thank you for that. And then just quickly on the weather impact. You guys managed to exceed your expectations and guidance on a number of lines in the P&L. I am curious what might have happened had the weather cooperated?

Graham Farrar

Yeah. It’s a good question. And I think it really highlights the power of our SoCal Farm. So we had one of the darkest readiness December and January on record and then that fuels the production for Q1 for us.

So I think, if anything, it really shows the power of that farm to manage the climate and mother nature of us. We like mother nature being against, probably, because it’s free and it doesn’t have any environmental impact.

The downside is sometimes you put curb balls and the upside of our facility is the ability to manage and kind of polish and supplement those curb balls to keep giving the plants what they want.

I mean I think if you have seen the normal seasonal weather, you would see these numbers even higher. I think that’s part of what gives us confidence in what we are doing and where we are going and why we are excited to turn on that 9 million square feet.

Bobby Burleson

And is there a piece of your guidance for the year that you guys are standing by where you think you are being particularly conservative? Is it the cost of production, for example?

Mark Vendetti

Bobby, I would just say that the one place that I hope we can do better is a continue after Q2 potentially take the production number up for the back half of the year. But, I mean, we are already lapping 150,000 pounds from last year. So we are still being -- we are guiding to basically up 28% in the back half of the year. But I think that -- to me, that would be one place I hope we can do better, because it has such a positive economic impact on the company’s number.

Bobby Burleson

Fantastic and congratulations.

Operator

Thank you. The next one is from Scott Fortune from ROTH MKM. Please ask your question.

Scott Fortune

Yeah. Good afternoon and thanks for the question. Obviously, we have seen the shakeout of cultivators, we have seen those licenses come out. Just kind of give us the environment on the retail side and taking out? I know your strategy has kind of been stores kind of limiting your retail growth beyond your 11 stores, but kind of how you are looking at the retail side of things in California going forward for you? And obviously, since, what’s the timing or what needs to happen for a healthier retail environment in California and potential timing on that occurring, that would be helpful?

Graham Farrar

Correct. I can take that. So I mean I think the most fundamental thing and it’s actually fundamental to the market on a macro sense is the regulations, the too many regulations, the taxes are too high and there’s not enough retail, right?

We currently have about 11,000 liquor stores in California. There’s probably something like 900 dispensaries. There’s 77,000 places in California that you can buy a cocktail. There’s. 900 places you can buy a joint, right?

So that’s a fundamentally not the right number. You can look at all the other states and you can see much closer to one dispensary for every 5,000 people, California has got a dispensary free for every 40,000 people, right?

You look at Montana, which has 1 million people and sold $300 million worth of cannabis. If you apply that same metric in California. California’s legal market should be $13 billion instead of $5 billion, right?

So there’s a fundamental broken piece here, which is not enough ways for companies like us who only sell licensed products to reach consumers. The secondary piece of that is where there are dispensaries, they are concentrated and lead these wider lead deserts. Something like 60% of the municipal in California still don’t have licensed legal retail and then you have other places like a Palm Springs, where you have got 20 dispensaries and it should be five.

So I think our view is that retail from where we are in the market is strategic that allows us to access have shelf space, connect with the consumer, it’s a great beta platform, it’s an amazing source of data and analytics towards our goal of making better products.

It also gives us a place that if we need to hunker down, as the retail kind of goes through the shakeout similar to what cultivation line, we know that we can reach consumers with our products. It’s also a strategic tool, because it’s in a tight competitive market, having a shelf to trade is valuable.

So I think from here, where 10 stores open, our eyes are not close to retail as long as the retail is in places that make sense, limited license markets places where we can run a business that does 20% EBITDA margins or better. So you can deal with, again, the owners to having taxes that particularly hit retail.

So I think our eyes are open. We have got a nice footprint where opportunities come along, either be de novo licenses or acquisitions that make sense for our strategy, connecting with consumer’s volume and moving our brands, we will, of course, consider it, but it’s not something that we are in a rush to do except for where it makes good business and financial set.

Scott Fortune

Got it. I appreciate that. And then kind of follow-up for me. As far as demand from the wholesale side, can you provide a little more color of who’s coming in, obviously, a lot of reliable suppliers are leaving the market and you guys are left with a good quality opportunity for that and there’s less brands in the market. But a little color on the wholesale side, are these new brands that you are now line or expanding the existing brands using plant [inaudible]. Just a little more color on the end market for the wholesale side of what you are selling?

Graham Farrar

Sure. Yeah. So, fundamentally, just as a reminder on our set strategy, which is the best possible cannabis for the best possible price. So, so far, on the left-hand side of the cost curve and so high up on the quality curve that it kind of no matter what’s going on in the market. It’s an undeniable value in what we grow and produce, will clear the market kind of prices up or prices down.

Now you take that focus, which we have been working on for seven years and going on eight years now, and then the facility that we are lucky enough to work in. And then you add to that, the license attrition that Mark was talking about, right, where we see it’s coming up on 20% in 10 months, 11 months of the cultivation licenses that should have read did, right? And I think that’s reflective of the pain of the last two years.

So there’s just -- there’s many people who are saying, basically, I can’t grow good enough product for lower costs to continue to operate given where the market is at. So that production is driving people towards us. Obviously, we do a lot of product into our brands. We do work with a lot of brands directly. We work with distributors or then distribute to other brands.

So you see our flower filling up in a lot of different brands all around state. It’s becoming, I think, one of the foundations of the market, because again, that high quality, low cost combination is a tough one to beat.

Scott Fortune

Got it. And then real quick, the distribution strategy, you are not moving away completely from using distributors or is this from a higher cost standpoint that you are kind of from a strategic standpoint and your own distribution, just kind of a real quick color on that?

Graham Farrar

That’s a great question, Scott. Yeah. That’s a great question, Scott. I mean, right now, we have not started on distribution nor do we have plans in the works to do so. We are working within the model of people that have done a great job.

We are still clients favorable and as we have for a long time, but we are watching the landscape carefully to see how things go. But, so as of right now, we are still using outside distro and I think that’s sort of our plan for the -- certainly for the immediate future.

Scott Fortune

Got it. Congrats again on that petition an I will jump back in the queue. Thanks.

Kyle Kazan

Hope to see you soon, Scott.

Operator

Thank you. Your next question is from Jesse Redmond from Water Tower Research. Please ask your question.

Jesse Redmond

Hey, guys. Congratulations on the quarter. Just to elaborate a bit on Scott’s question. I feel like I am in touch with the wider issues in California on the retail side, limited access, high taxes, really tax burden. But specific to your network of stores, you pursue more limited license environments exemplified by the newer stores in Santa Ynez and Isla Vista and I was wondering if you are seeing the same pressure others are seeing on the retail side or if you are finding you are a bit more insulated from that with your locations?

Kyle Kazan

That’s a great question. We do have some locations that have a lot of competition like Santa Ana certainly has a lot and then we have one of five licenses in Berkeley, which is -- which are -- but Oakland, which has a lot of licenses.

So we sort of have a mix. Our Santa Barbara stores, for sure, don’t have that same competition. And you would absolutely notice the difference in those markets where you just have Santa Ana, I think, has 20 licenses and now Costa Mesa is coming online.

So any new industry faces these kinds of bumps as it grows? I will say this, the future when we consider new potential stores the ones that have limited licenses at least at the beginning are the ones that are interesting.

Jesse Redmond

And had the IV and Santa Ynez, IV stand for Isla Vista, have Isla Vista and Santa Ynez stores been in line with our expectations or how -- what are your thoughts on those so broad?

Kyle Kazan

I think it’s a little slower to go out to gate than we had expected, but we know they are both very, very good markets. We have a good base in Santa Barbara. I know in Isla Vista people smoking cannabis, that’s not an issue. It’s making sure that, they know about us and that they choose us over the illicit market. So we are -- it’s a work in progress, but we are still optimistic.

Jesse Redmond

Thanks. And on the wholesale side, it seems like logically, we should see prices improve or be consistent at least through the summer. We typically have that light depth harvest maybe in June, that’s ready in late July and then we have cropped over in October. But with the reduced canopy, I am curious what do you think the effects will be of that light depth harvest, and more specifically, looking out through this fall, where we typically see the drop in prices. We didn’t see that as much last year and this year with even fewer licenses. I am curious how you are thinking about that October effect in this new reduced canopy environment.

Kyle Kazan

Graham, do you want to take that?

Graham Farrar

I think it will -- yeah. No. I think it will be muted. I mean I -- we will see more supply than we have seen here today, for example. But the licenses that have been expiring over the last year, like, it’s -- that’s -- you don’t quickly recover from that, right?

It’s not as if the license expired in change your money 60 days later and decide we want to reactivate it. Typical time to turn on and get lessened with an annual license is something like 180 days to 200 days.

So once the license expires, you have got to go back to the process to do that. So I think we will see a pretty muted effect. I’d be ready for the prices were to recovering, people who are still cultivating are going to be more likely to not scale back their production they might have if prices were lower, but I do think it’s going to be pretty stable.

And I think we are returning to a point where the market -- you can’t have sales prices below your marginal cost of production for extended period of time, because what happens -- is what we are seeing happen, which is supply falls out, because it doesn’t make sense to them until prices rise until there’s enough oxygen for enough people to supply the demand to continue to exist. So might we see a plateau? Sure. Do I think we are going to ride the roller coaster again? That’s not my prediction.

Mark Vendetti

So one crop again…

Jesse Redmond

Okay. Thanks.

Mark Vendetti

I’d just add one thing to that, and Kyle mentioned it, over -- during the month of May and June, basically one out of four active licenses in the state up for renewal. So as we move through May and June and we see what happens, then I think that’s going to go a long way to determining what happens in the second half of the year. If a lot of those leave the market, I think, prices will definitely remain stable in the second half of the year.

Jesse Redmond

Okay. Thanks, guys. Congratulations again. I look forward to seeing you next month at the Investor Sesh.

Kyle Kazan

Hi. That’s awesome. We look forward to you too.

Jesse Redmond

All right. Thanks, guys.

Operator

Thank you. [Operator Instructions] The next one is from Howard Penney from Hedgeye. Please ask your question.

Howard Penney

Thanks very much for question. I was asking a question about the retail network and your desire to grow that network, while at the same time, maintaining your free cash flow sales given the high capital expensive nature of the retail network? Thanks.

Kyle Kazan

Graham, do you want to take that?

Graham Farrar

Sure. Yeah. And Howard, if you can maybe just clarify a little bit, I am not sure I probably understood the question.

Howard Penney

Yeah.

Graham Farrar

Yeah.

Howard Penney

So it was an important milestone that you got to a free cash flow position this quarter. If I am hearing you right and you are wanting to grow the retail network, your retail store base that will require a lot of capital you should -- you are not going to be in a free cash flow position. So I am curious as how do you maintain your free cash flow position while also growing the retail network?

Graham Farrar

Got it. Yeah. So a few things there. One, free cash flow positive and staying there is, in fact, we are saying it is important to us. A reminder that Q1 was actually seasonally our lowest quarter because of less light, less yields, less revenue on the cultivation side. And so as we move through the year, we expect that accelerate more light, more yield, more revenue. So we do believe that we will be into a position where we can grow from operations.

That said, I think our stance with retail is kind of watch and wait for the real winners, right? And I think we believe that retail is going to go through a bit of a shape out. The excise tax that we mentioned that made from the distributor to the retailer. That’s a personal tax liability.

So it’s not discharged by dissolving the business or bankruptcy or things like that. So I think there is going to be a handful of operators out there that are going to be looking for ways to deal with that and not make create opportunities for us.

And otherwise, it’s really just going to be a decision of what’s the ROI? How do you make the investment? Are there places where you can get de novo license even open up capital efficient ways that provide good or to move forward through the year, we expect that we are going to be able to do that basically from operations to make those things happen.

Howard Penney

And…

Kyle Kazan

And Howard, I would …

Howard Penney

Yeah.

Kyle Kazan

As a follow-up, I would tell you that, I know in the cannabis industry, there’s always this land grab, especially in new states for retail. We question that quite a bit inside our company where we say, what’s the value in 7-Eleven and Circle K also have stores.

So long-term, I would tell you that, we are not involve -- we don’t think the land grab is a way to go and -- but we will be particular on some opportunities, because we think we are a value-add to stores that might want to have us help them manage it, things like that.

But capital allocation to go buy existing successful stores is not likely in our future, but we could open up some that we think where we have some opportunities very cheaply. So we are mindful of cash.

Howard Penney

So married model might make a lot of sense, I should think about it that way.

Kyle Kazan

Maybe? I may have stepped over Mark. Mark, do you want to say something?

Mark Vendetti

I was -- Kyle, all I was just going to say is, all of the outlooks we provided for this year just continue to assume the 10 stores we now have open are in our baseline and there are no plans currently that have any stores coming in soon. And again, I think, Kyle, phrased it very nicely in terms of thinking about how we would consider additional retail stores. But we are at 10 and our plans are built up 10.

Howard Penney

Perfect. And I guess what I wanted to hear at least, you are not intending to be land grab strategy, which has proven disastrous in this industry. Thank you.

Kyle Kazan

Welcome.

Operator

Thank you. Your next question is from Mike Regan from Excelsior Equities. Please ask your question.

Mike Regan

Hi, everyone. Thanks for taking the question. [Technical Difficulty] Is pretty great to see and also the [Technical Difficulty] expectations on that average pricing. So sort of two questions. One, is there any impact in that from quality mix upwards, sort of just larger flowers or a larger percentage of the bio methane, higher end flower? And second, sort of I guess, where do you think that can sort of ultimately go as all the capacity keeps coming off-line?

Graham Farrar

Yeah. So I can that. I think the first half of your question, I think, it’s worth a reminder that we are still about six weeks away almost from our one-year anniversary of the first pound that we sold out of our SoCal facility.

So big picture, still quite early down there and still very much learning, but very happy with where we are today and expect that additional experience will continue to improve our quality, as well as our efficiency and costs.

So we are seeing that, that greenhouse does allow us to help increase the ratio or the mix as we call it of flower relative to smalls and trim flower trades at a significant premium to both smalls and trim. So the more flower that we can produce as a percentage, the more that helps the average selling price. So I do think we will be able to push on that.

Also, as the days go by, our quality continues to improve and I think we are getting very close to mixed light and even indoor quality down there in many cases and that’s something that the team strives to make the exception becomes the norm and we keep pushing that upward.

I do think that, as Mark mentioned, and Kyle mentioned, just kind of structurally in the market, there’s a whole lot of licenses that are not going to be able to make it across the provisional annual threshold and you can no longer renew those licenses over 22,000 square feet.

You have to be some compliant now. Those are kind of back-end loaded, because of when the provisional licenses could no longer be issued, there was a push to get the licenses in. And in the next few months, we see a significant portion of that market that is going to have to either have made it over the hurdle or no longer view there.

So I think we will continue to see significant attrition in the market. Hard to say exactly where pricing goes, we are pretty happy with it right here. So if it stayed in the zone, we would be half amperage.

Mike Regan

No. Yeah. That’s basically what I am asking is that the guidance implies is continuing to increase even beyond the $3.25 to get to $3.30 for the year. So I was just trying to wonder like what’s that, if you exit December, call it, $3.50, is that sort of the upper limit or is that -- when you have the -- as you point out, you are still trying to figure out how to get even better product out of the greenhouse and we have opportunity beyond that?

Graham Farrar

Yeah. I mean, I think, I would say, there’s more cannabis consumers today than there ever have been and they will be more tomorrow than today. So as we move forward, I think, demand is going to continue to go up and to the right, particularly in terms of units and volume.

And I think that you are going to continue to -- it’s kind of embedded in the system almost that you are going to continue to see supply attrition and the pivot back in is a lengthy process. So it won’t happen particularly quickly.

Obviously, as we move forward, if you look around California, California still has the lowest price cannabis I believe in the country right now, right? So as happy as we are to see the market recovery, every other state is looking, and probably, can’t quite imagine how they would even function with the prices that we have today, right?

And that’s one of the things that we like about where we sit is, we are happy right here and for most other states and many other places, this would be something that they wouldn’t even know what to do with. So long-term big picture we like where we are at structurally and think the wins will continue to be at our back.

Mark’s thrown some real-time information here right now. So far, in the first two weeks of May, we have seen 107 licenses that have left already. So that’s -- those are typically 10,000 square foot licenses. So basically in the last two weeks, we have seen another 1 million square feet of supply that is not renewed and falling out of the market. So the trend continues.

Operator

Thank you. [Operator Instructions] There are no questions at this time. Please continue.

Kyle Kazan

I think we can wrap it up, Operator. Thank you.

Operator

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.

Kyle Kazan

Thank you.

Mark Vendetti

Thank you, everyone.

Graham Farrar

Thank you.

John Brebeck

Thanks, everyone.

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Glass House Brands Inc. (GLASF) Q1 2023 Earnings Call Transcript