GLASF | NAVIGATING CHALLENGES, HARNESSING INNOVATION FOR THE FUTURE

Glass House Brands Shines in 3Q23: Navigating Challenges, Harnessing Innovation for the Future

Glass House Brands (GLASF) 3Q23 Revenue of 48.2M beats by 2.7M, and Adjusted EBITDA was 10.7 million versus 9.5 million in 2Q23. Notably, the Cost per Equivalent Dry Pound of Production dropped to a record low of 118 per pound, down 12% versus Q3 2022. Guidance for 4Q23 is light, with estimated revenues of 38-40 million.

Glass House Brands (GLASF) is a Hedgeye Cannabis Best Idea Long. 

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Key Financial Highlights

• Revenue:  Record 48.2 million, up 71% year-over-year and 8% sequentially.
• Gross Margin: 54%, a significant improvement from 31% last year.
• Biomass Production:  Increased by 36% year-over-year, with Revenue from this segment up 142%.
• Adjusted EBITDA:  Rose to 10.7 million from 9.5 million in Q2 2023.
• Operating Cash Flow:  Achieved a record 9.1 million, an increase from 8.3 million in 2Q23.
• COGS:  Cost per Equivalent Dry Pound of Production Dropped to a record low of 118 per pound.
• Average Selling Price:  Increased to 336 per pound, a 65% rise from the previous year.

Other Important Financial Data and Trends

• Cost Management: Cost per pound of cultivation fell to a record low of 118, underscoring efficient cost management.
• Regulatory Environment: CEO Kyle emphasized the need for regulatory improvements, advocating for less regulation and suspension of excise tax.
• Market Dynamics: Discussed the challenges in the California cannabis market, including competition with illicit markets and uneven distribution of legal dispensaries.
• Future Outlook: Expressed optimism about potential DEA rescheduling of cannabis and the impact of the 2024 presidential election on the industry. The potential positive impact on the balance sheet is significant. 

Key Themes (ranked by Importance):

• Market Leadership Potential: Glass House's significant growth in biomass production and sales positions them as a potential market leader, especially as we head toward interstate commerce.
• Regulatory Risks and Opportunities: DEA rescheduling could be a game-changer, offering risks and opportunities depending on the final policy outcome. Details TBD
• Environmental Resilience: The company's ability to navigate challenging weather conditions suggests strong operational resilience, which is essential for long-term sustainability.
• Competitive Pressures: The ongoing competition with illicit markets and regulatory hurdles could continue to pressure margins and market share.

Glass House And Environmental Resilience

In summary, Glass House Group's experience with environmental and weather challenges highlights the complexities of agricultural production, especially in a changing climate. Their ability to adapt and learn from these challenges is critical to their operational strategy and future success. Indeed, the environmental and weather challenges Glass House Group faces are a headwind this quarter, but it comes with the territory and does not change the long-term potential. Here's a detailed look at the 3Q23 issues:

Unusual Weather Patterns: The company experienced highly abnormal weather conditions throughout the year. This included an entire month of rain in January, which was unusual for California and ended a multi-year drought. Such heavy rainfall can impact cannabis cultivation, potentially affecting plant health and harvest timelines.

Variability in Sunlight and Temperature: The year saw more than 10% below the 10-year average in sunlight levels. For a crop like cannabis, which relies heavily on sunlight for growth, this can lead to reduced yields or delayed growth cycles. Additionally, higher humidity and temperatures, particularly unseasonal ones, can create challenging conditions for cannabis cultivation, potentially leading to issues like mold or pests.

Extreme Weather Events: Management mentioned specific events like hurricane warnings, bomb cyclones, and the first tropical storm to hit California in recorded history. These extreme weather events can cause direct damage to crops and infrastructure, as well as indirect impacts like disrupting the supply chain or cultivation schedules.

Adaptation and Resilience: Despite these challenges, the company's cultivation team has been adapting to these conditions. For instance, they learned from the extreme heat of the previous fall and made adjustments. This suggests a level of resilience and ability to adapt to changing environmental conditions, which is crucial for long-term sustainability in agriculture-based businesses.

Impact on Production: Management noted that while they expect to exceed their production compared to the previous year's fourth quarter, the environmental conditions would likely result in a lower percentage of flower than typical for the fourth quarter. This affects the overall selling price and could impact Revenue.

Comparison with Indoor Cultivation: Its important to contrast their approach of using natural conditions for cultivation with other companies that grow cannabis in controlled indoor environments. While indoor cultivation offers more control over environmental factors, it comes with higher costs and environmental impacts. Glass House's reliance on natural conditions, while challenging, is presented as a more sustainable and cost-effective approach.

Glass House Group's Approach to Supplemental Lighting

Glass House Group's proactive approach to using supplemental lighting demonstrates its commitment to Innovation and efficiency in cultivation. By leveraging advanced lighting technology and on-site power generation, they are addressing the challenges posed by variable natural light conditions and enhancing their overall cultivation process. This strategy is likely to yield positive results in terms of both crop quality and operational efficiency. Graham Farrar had detailed insights into their ongoing efforts and findings. Key Points from Graham Farrar's Response:

1. Long-Term Testing: Glass House has been conducting supplemental light testing for around 20 months, gathering substantial data to inform its strategies.
2. Three Categories of Testing:
• Supplemental Grow Lights: Focused on enhancing the growth phase of the cannabis plants.
• Supplemental Veg Lights for Nursery: Aimed at improving the vegetation stage in their nursery setup.
• LED Lights in Clone Domes: Installation of low-output but crucial LED lights in clone domes has shown positive results.
3. Strategic Advantage of On-Site Power Generation:
• Glass House's SoCal greenhouse is equipped with 11,000, 1000-watt High-Pressure Sodium (HPS) lights.
• They have the capability to generate all the required power on-site, which is both cost-efficient and environmentally friendly.
• This setup provides a significant strategic advantage, allowing them to use heat and CO2 effectively and produce power at a lower cost than purchasing.
4. Benefits of Supplemental Lighting:
• Yield Improvement: Supplemental lighting has been shown to enhance the actual yield of the plants.
• Climate Control: It offers better control over the cultivation environment, allowing for more effective temperature and humidity management.
• Operational Flexibility: More light availability allows for higher temperatures and lower humidity levels, which are optimal for plant growth.
5. Impact on Future Production:
• Implementing these lighting solutions is expected to make a significant difference, especially in quarters with low natural light, like Q4.
• All the new lighting installations are scheduled to be completed by the end of the month.

California Cannabis Market Update

In summary, the California cannabis market offers substantial opportunities but is fraught with challenges, including competition from the illicit market, regulatory complexities, and uneven market access. Companies like Glass House Group are navigating this landscape by focusing on cost-effective cultivation, regulatory advocacy, and adapting to market dynamics. Here are some detailed insights from the Glass House earnings call:

Market Size and Potential: The total California cannabis market is estimated to be around 10 billion to 12 billion. This size indicates a significant market potential for cannabis companies operating in the state.

Illicit Market Competition: A significant challenge highlighted is the competition from the illicit market. It's estimated that at least half of the cannabis demand in California is supplied by this illicit market. This presents a significant hurdle for legal operators in terms of competition and in shaping market dynamics.

Regulatory Challenges: The cannabis industry in California faces a unique and fluid regulatory structure. This includes issues like counties without legal dispensaries, creating "weed deserts," and areas with an oversaturation of dispensaries leading to intense competition. The regulatory environment is also impacted by legal retailers not paying state excise taxes or their suppliers, adding to the industry's challenges.

Dispensary Distribution: Over 65% of counties in California still do not have a single operating retail dispensary. Conversely, more than 40% of all legal retail stores are located in just seven municipalities. This uneven distribution creates challenges in terms of market access and competition.

Impact of Illicit Operations: In cities like Los Angeles, legal dispensaries like Glass House's 'The Pottery' face competition from a constantly changing lineup of illicit operations. Authorities often shut down these illegal entities but tend to reopen in new locations, creating a persistent challenge for legal operators.

Industry Consolidation: The market is currently undergoing a period of consolidation, expected to continue for at least the next 12 months. This could lead to a more stable market environment in the long term but presents short-term challenges.

Consumer Preferences: There is a significant demand for legal, safe, and regulated cannabis products. This suggests a market opportunity for companies that can navigate the regulatory and competitive landscape effectively.

National Policy and Legal Developments: The potential for changes in federal and state policies, such as DEA rescheduling of cannabis, could significantly impact the market. The 2024 presidential election is also seen as a potential catalyst for policy changes.

Medical and Recreational Use: The use of cannabis for medicinal purposes is growing, with increasing acceptance among various age groups. This diversifies the market beyond recreational use and could drive growth in specific product segments.