Glass House Brands Inc. (GLASF) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Glass House Brands' Second Quarter 2021 Conference Call for the 3-month period ending June 30, 2021. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions asked could constitute forward-looking statements that are subject to risks and uncertainties relating to Glass House Brands' future financial or business performance. Actual results could differ materially from those anticipated in forward-looking statements. The risk factors that may affect results are detailed in Glass House Brands' periodic filings and registration statements. These documents may be accessed via the SEDAR database. I'd like to remind everyone that this call is being recorded today, August 17, 2021. I'd now like to introduce Mr. Kyle Kazan, Chairman and Chief Executive Officer of Glass House Brands. Please go ahead, Mr. Kazan.

Thank you, operator. Good morning, everyone, and thank you for joining us for today's call. With me are Derrek Higgins, our Chief Financial Officer, who will review our financial results; and our President, Graham Farrar, who will join us for the Q&A later on. As this is our first quarterly call, I would like to take a few minutes this morning to review our strategic priorities and provide an overview of our business and positioning and then Derrek will discuss our financial results. Afterwards, Derrek, Graham and I will take your questions. Following the completion of our business combination with Mercer Park Brand Acquisition Corp. in late June, we have successfully created Glass House Brands Inc. with the vision of becoming the largest cannabis brand building platform in California. That vision remains constant and unchanged. Today, we operate one of the strongest retail and wholesale networks in the state supported by our best-in-class cultivation processes and our scaled and highly efficient cost structures. It's been approximately 50 days since completing the transaction and I am incredibly proud of the work that has been done to transition into a publicly traded company. Following the transaction, we are well funded and remain well positioned to capitalize on the growing California national CPG opportunity ahead of us. Our strategic priorities coming out of our qualifying transaction continue to be to scale our cultivation, increasing our capacity and our quality while reducing our costs to improve the breadth and depth of our product portfolio and execute our growth strategy through planned cultivation, retail dispensary acquisitions and mergers. I am pleased to report we have made significant progress against these strategic goals. With our expansive cultivation, retail and wholesale footprint, we continue to leverage our position in California to introduce high-quality, sustainably grown craft cannabis to the market, in an effort to support the growing demand we are seeing from our consumers while having a lighter and greener touch on our environment. Today, we operate a cultivation footprint of over 500,000 square feet, producing over 80,000 pounds dry equivalent of biomass per year. We recently provided an update on our pending acquisition of a 5.5 million square feet state-of-the-art Southern California facility. Additional capacity is expected to increase our current footprint up to approximately 2.5 million square feet by 2023. And our total targeted footprint of 6 million square feet will position us as the largest cultivation capacity in California by far. We continue to believe that the Southern California facility is a unicorn asset that will allow us to produce cannabis on par with the very best in the state and the country at an eventual scale that will allow us to service the entire country when that opportunity arrives. Since our inception in 2015, we have focused on incorporating leading-edge technologies and cultivation techniques to produce exceptional cannabis products for medical patients and consumers. We continue on our commitment to finding innovative techniques that allow us to expand our output while being as efficient and sustainable as possible. On the retail front, we currently operate 4 award-winning dispensaries in California. And during the quarter, announced that we were awarded 2 additional retail licenses de novo in Santa Barbara County, one in Santa Ynez and one in Isla Vista, both of which we expect to open in the first half of 2022, bringing our internal retail footprint to 6. We continue to make progress towards our goal of rolling out an additional 13 dispensaries, which will bring our total retail footprint to 19 open locations by the end of Q2 2022. Looking at our CPG business, we ended last year with a top 5 brand in the flower category. That is the largest category, which equates to 49% of all sales in the world's largest market of California. We ended the second quarter with approximately 340 retail doors to our CPG distribution and have maintained our position as a top 5 brand. Depending on the chart, we are #1, #3 or #5. Our aim is to continue reaching many more dispensary statewide and will leverage our leadership position in California to capitalize on the potential nationwide opportunities that would result from federal legalization. In addition to our cultivation and retail footprint, I'm very proud of the progress we have made in building a differentiated brand portfolio to meet the needs of our consumers. Our portfolio includes: Glass House Farms, our first flower brand for the everyday cannabis consumer; Forbidden Flowers, a female millennial and Gen Z targeted brand through our partnership with Bella Thorne; as well as Mama Sue built with well-known industry activists, Sue Taylor. We continue to build out our portfolio and look forward to introducing new brands and products to consumers. We believe that the combination of a large-scale, high-quality cultivation, combined with a large retail footprint will allow us to build a portfolio of strong brands. It will be a critical component of our success. Looking briefly at the quarter before turning it over to Derrek to provide a more in-depth view, we generated net sales of $18.7 million and sustained positive adjusted EBITDA. This was short of our target, and I'd like to provide some context on the operational challenges we faced, which caused the miss. Our primary challenges related to the ramp-up of production at our new and larger cultivation facility, the 355,000 square foot property, in the second quarter, which had an outsized impact on both our anticipated yields and cost of goods sold. We fully planted all 5 greenhouses at the Padaro facility in the fourth quarter of 2020 and commenced our first harvest at the beginning of the quarter. Our original plans, however, proved to be aggressive given that we made them prior to running the facility at full capacity. We extrapolated projections using a combination of data from our smaller facility, the 150,000 square foot property at Casitas, coupled with promising early results achieved at Padaro in the second half of 2020. There were 3 primary issues at Padaro, which contributed to our underperformance in cultivation. We've been working on a new processing warehouse on the site and initially planned to fresh freeze a significant amount of biomass since we had insufficient on-site dry cure space. Market and product conditions caused us to reevaluate, reducing our fresh frozen and increasing our dry allocations. As a result, we had to make a number of operational decisions, including utilizing space at our manufacturing facility for post processing and outsourcing capacity to third-party vendors. Neither of these changes were ideal and have raised our processing COGS. The Padaro farm climate controls proved to be inadequate for the more humid times of the year. As the initial results came in favorably and with a desire to conservatively manage our capital resources, we opted to try to save between $1 million and $1.5 million by not replacing the heating system. This proved to be a poor decision as a lack of climate control resulted in reduced yields and increased processing costs. The roof material at Padaro farm had a lower light transmission than was expected. Our initial data was collected at the highest light time of the year and we used to forecast for the full farm output. In the lower light periods of the year, the impact of the lower light transmission had a significantly higher impact, reducing yield. We are currently halfway through replacing the roofs on all 5 greenhouses with higher light transmission material, which are expected to significantly improve results. As we pride ourselves on being one of the best low-cost, high-quality growers in the state, we're determined to fix this quickly so that we can maximize that efficiency. This, along with being careful stewards of our and our investors' capital has resulted in us making additional data-supported capital investment decisions. While the issues at Padaro were different than the problems we tackle at Casitas, they are all solvable. The difference now is that we are under contract to purchase the Camarillo facility, which on its worst day, its worst day is far better than both of our current farms on their best days. The silver lining is that we feel that our investment thesis has been proven correct. Higher light levels and more climate control produce better quality flower at lower costs. This is exactly why we remain excited about the Camarillo farm acquisition, especially as the media is beginning to report just how large the carbon footprint is in growing cannabis indoors, both locally and around the country. As an example, 10% of Massachusetts electrical grid is being used by cannabis operators. Given that, we are looking to accelerate the shift in our focus to flower production going to Camarillo, we decided to limit the investment at Padaro to installation of a new roof system to allow more natural light into the greenhouses, enabling us to continue improving both yield and product quality without increasing our carbon footprint or operational costs. In addition, we expect, upon completion, to reduce the energy required to produce each pound of flower by approximately 20%. We are considering changing the heating system to dry heat as the humidity problem exacerbates during flowering. We are determined the use of this farm after the shift to Camarillo. We'll make the investment decision shortly. With the addition of the Camarillo facility, we are evaluating that is it still necessary to invest the approximate $6 million to $7 million needed for a new warehouse and that we can instead relocate all processing to the Camarillo facility. While the team is [ ready ] and quick to find efficiencies, I expect that some problems will persist until we bring our production in Camarillo online. Before I turn the line over, I'd like to remind our listeners of our strategic priorities coming out of our go-public transactions. First, as previously mentioned, we remain committed to scaling our cultivation activities and expect to close on our previously announced acquisition of the 5.5 million square foot state-of-the-art, Southern California greenhouse shortly. Southern Cal greenhouse currently operates as an agricultural producer consisting of 6 hi-tech environmentally controlled agricultural greenhouses totaling the 5.5 million square feet, located on 160 acres in Ventura County, California, that will transition in phases to a cannabis facility upon regulatory approval. We believe that this asset in combination with the Glass House team will give us a competitive advantage that few will be able to compete with. Earlier this month, we announced that we agreed to amend the closing terms of the agreement with the seller, and we'll now close escrow following receipt from Ventura County that the final building permit issue at the facility has been signed off. In addition, the sellers have agreed to carry a $30 million note on favorable terms through the issuance of the California State Cannabis License or the end of 2021, whichever is sooner. And we expect to complete the acquisition this quarter, in quarter 3 of 2021 using cash on hand, subject to local regulatory approval. Once we close, we expect to immediately begin the first phase of conversion of the agricultural greenhouses to cannabis cultivation, which will result in the upgrade and retrofit of approximately 1.7 million square feet of the facility. With this acquisition, we'll be ideally positioned to lead the California cannabis market with our unmatched capacity and we'll be well positioned to scale our production to yield some of the highest quality cannabis to meet consumer demand and support the expansion of our wholesale business. Second, we have an aggressive retail dispensary acquisition plan, which will fuel the rapid growth of our business as we move into 2022. We continue to make progress here. And during the second quarter, we announced that we were awarded 2 new retail licenses in Santa Barbara County to open adult-use dispensaries in the highly sought after Santa Ynez and Isla Vista locations. We expect these 2 locations to be operational at the end of the first half of 2022. With these 2 additional licenses, we increased our internal retail footprint to 6 locations throughout California, adding to our existing operating locations in Santa Barbara, Berkeley, Santa Ana and Los Angeles. Population of more than 500,000 in Santa Barbara County, the new retail dispensary locations are strategically positioned along U.S. 101 or Pacific Coast Highway to service local residents and support the region's robust year-round tourism industry. Each of the planned dispensaries are located in regions that are only approved for a single license, which is a testament to our team's history of quality operations and ability to secure licenses in complex and competitive regulatory environments. In addition to our current footprint, we previously entered into an agreement to merge with 17 in-process retail license entities from Element 7, a California company with a proven track record in winning licenses. These licenses together with the 2 new recent Santa Barbara license awards are expected to bring our retail footprint to 23 locations in total with 19 operational by the end of the first half of 2022, which will represent the highest state-wide store count of any single California cannabis operator. Finally, we continue to focus on building world-class leadership and management teams. And earlier this month, we were thrilled to welcome Erik Thoresen, as our new Chief Business Development Officer. Erik will be responsible for spearheading M&A initiatives as we capitalize on our California-based and potential national CPG opportunities. He joins us with nearly 20 years of global investing, capital allocation and transactional experience, over 15 years of experience in M&A and 12 years of non-market proprietary deal flow experience. Erik will play a critical role as we continue to roll out and scale our wholesale business. We also recently announced that Joe Aulenta has joined our team as our new Director of Retail Construction. He has 15 years of construction and store design management experience and over 20 years of merchandising experience, most recently working as a Senior Project Manager of Real Estate Construction for Foot Locker. He will be instrumental in managing, execution and build-out of our retail network as we execute against our goal of 19 stores by the end of the second quarter of 2022. All of these efforts, together with our unique leadership position in California and strong balance sheet have positioned our company for sustainable long-term growth. I look forward to continuing to update you on our progress as we continue to execute over the coming weeks and months. And with that being said, at this point, I would like to now turn the call over to Derrek, who will discuss the financial highlights of the second quarter.

Thanks, Kyle, and good morning, everyone. As a reminder, the results I'll be sharing today can be found in our financial statements and management's discussion and analysis published on the SEDAR database to reported in U.S. dollars and prepared in U.S. GAAP. Starting with our income statement highlights. Revenue for the quarter ended June 30, 2021, totaled $18.7 million, climbing $7.1 million or 62% year-over-year. We separate revenue into 2 business categories, wholesale and retail. Wholesale is our B2B business, selling both biomass and consumer products to other licensed cannabis businesses. Wholesale revenue increased by $4.3 million or 54% year-over-year. This increase was primarily due to an increase in cannabis production from our second greenhouse cultivation facility, our Padaro farm, which commenced limited operations in Q1 2020 and was fully operational by the end of the year. Retail is our B2C business, selling packaged products to end consumers through retail stores we control. Our Los Angeles-based dispensaries, The Pottery, is reported as an equity method investment given its current ownership structure and therefore, is not consolidated with our retail revenue. Our cannabis retail dispensaries contribute consistent revenue growth increasing $2.8 million or 77% in Q2 2021 compared to Q2 2020. Our Berkeley store, which we acquired in Q1 of this year, accounted for $1.7 million of this revenue growth. This past quarter, we made modifications to our rewards and loyalty program that resulted in a onetime favorable adjustment to revenue of $1.2 million. Excluding this adjustment, existing store revenue declined 4.7% year-over-year, consistent with the broader California market as the state eased stay-at-home restrictions. We ended last quarter with $8.6 million of gross profit and a 46% gross margin compared with a gross profit of $5.5 million and a 48% gross margin in Q2 2020. The decrease in gross margin percent was driven by increased product, labor and overhead costs associated with our previously mentioned post-harvest processing challenges we experienced ramping up the Padaro farm. In Q2 '21, total operating expenses increased $3.4 million year-over-year to $9.6 million compared to total operating expenses of $6.2 million in Q2 2020. The majority of this increase was associated with professional fees, which increased $1.4 million year-over-year, for legal, accounting and other consulting services supporting our go public transaction and other key initiatives that occurred during the second quarter of 2021. General and administrative expenses increased $1.3 million year-over-year to $5.9 million, on increased investment in operational expansion initiatives to support our corporate cultivation and retail operations. Sales and marketing expenses increased $600,000 year-over-year to $1 million with an additional investment in digital media, marketing and royalty expenses. We define adjusted EBITDA as earnings before interest, taxes, depreciation and amortization adjusted for transaction costs, restructuring costs, share-based compensation and other noncash operating costs. We ended last quarter with an adjusted EBITDA of $2.2 million compared to $1.1 million in Q2 2020. The increase in adjusted EBITDA was primarily due to higher gross profit, which was partially offset by our higher operating expenses. Moving to the balance sheet items. Cash increased by $129.8 million year-over-year, primarily from capital raised to our go public transaction. We ended the quarter with $134.3 million in cash and ample liquidity to close the Southern California Greenhouse acquisition, Kyle discussed earlier. Additionally, during the quarter, the company eliminated $38.3 million of debt through the completion of a preferred stock offering, exchanging both principal and interest accrued to participating investors and issued both company preferred stock and warrants, which triggered the equity conversion of all of the company's outstanding convertible promissory notes. As Kyle mentioned, we are well funded and well positioned to continue to execute on our growth strategy. And with our significantly improved balance sheet and large portfolio unencumbered cannabis real estate assets, we actively evaluate additional non-dilutive sources of capital to help fuel our future strategic initiatives. We are very pleased with the progress we have made this quarter and even more excited for what lies ahead of us in 2021. I would like now to turn it back over to the operator to open the line for questions. Pam?

[Operator Instructions] Your first question comes from Scott Fortune with ROTH Capital Partners.

Real quickly, I want to focus on kind of the CapEx or the cash levels you're at now and kind of the build-out as you look out into 2021, 2022 as you bring on the big greenhouse operations going forward. Can you step us through the costs associated with building that out going forward here?

So Scott, nice to hear from you. Let me ask Graham to comment on that, if that's okay?

Yes, sure. Scott, thanks for the question. I appreciate it. Just a quick note, too, as we say good morning here to recognize all the work of the Glass House team. Obviously, we're here presenting it, but there was an entire team of people doing great work behind us and wanted to make sure that we recognize the contribution that all of them are making. I think initially worth noting that there is no change to our strategy, right? Our goal is to build brands and products that consumers love. We believe that the way to do that is with high-quality, efficient, large-scale cultivation coupled with retail to create -- be able to create a brand by deciding to create a brand. As we get ready to move into Camarillo, there are some things that we need largely unchanged from our initial conversations that we've had around that build-out of additional retrofits around blackout and dry rooms and the systems such as that to allow the conversion from cannabis -- I'm sorry, from tomatoes to cannabis. As we mentioned, that greenhouse as it sits now, is better than any of the greenhouse facilities we have today. So while we had some challenges, particularly with the new firm, the silver lining into that, right, is that the things that we've been saying matter. We show it matter, right, more light, better climate control produces higher-quality cannabis at lower prices. So as we go into this, of course, we wake up and put our feet on the ground every morning, shareholders first. We think about our consumers, we think about our employees and we think about the shareholders behind them. So everything we do, we try and do with -- as the most efficient stewards of capital as possible. One of the benefits, I think, that we have is the 6-plus years of experience in doing these retrofits. This will now be the third one. We learned some lessons on the first one. We've learned some lessons on the second one. As we go forward on this, it should actually be one of on a per square foot basis, the easiest convergence that we've done. So we've got initial plan there, measured in the tens of millions of dollars, which will be done to start things off, licensing specific, cultivation specific and processing specific, so that we can get started down there as quickly as possible.

That's fair. Appreciate the color. And then real quickly, as you expand DTC, as you expand your retail doors, I know for the CPG side, you're at 340 doors here and looking to expand that in California. Can you step us through any kind of target level? Or what kind of coverage -- percentage coverage of California do you have right now as far as selling your brands into all the different dispensaries there? Just step us through kind of the costs associated with it or the expansion of distribution for your brands into California retail expense?

Yes, sure. So...

Let me just -- so Scott -- this is Kyle. What I would tell you is, we work with HERBL. And so the breadth of their reach is very long. We also have a sales team, which we are actively growing as well so that we're touching the stores. I would say the coverage right now is under 50%. So we feel pretty good that, again, whether we're #1, #2, #3, #4 or #5, top flower brand. We have a lot of stores to capture. There's plenty of growth there. And also, we've added different SKUs to our product selection so that we can get our flower out in many different forms to the different stores. So the answer to your question is, our direct sales team works both with HERBL and with the customers, and we're continuing to build that robust team.

Got it. Is there expectation for 50% coverage of California were kind of -- kind of how do we look at the cadence of getting up to the higher 90% plus coverage for all of California over time here?

There's quick growth and smart growth, and we're trying to make sure that when we pick up a store shelf, we're properly servicing that client so that we hold the shelf. We certainly have goals to continue to grow that footprint. But it's a measured approach by opportunities that are good for the stores and good for us.

One of the fastest areas -- this is Derrek speaking. One of the fastest areas that we see growth in CPG in the retail market is through our own stores that we own and control, where we see anywhere between 20% and 30% of the share of basket being devoted towards our products. So as we expand our retail footprint, we're excited to be able to expand the momentum that we achieved with our CPG brands in retail market.

While I appreciate the color -- go ahead.

One of the comment on that, too. I think as we mentioned before, we see 10 to 15x the sales in our stores as we see in an average third-party stores for our products. So as you can do the math as we bring these new owned stores online, what that equals to in terms of kind of third-party store equivalents and that's part of the synergy that makes us really excited about the strategy of combining large-scale, high-quality cultivation with brand creation and our owned retail. So I think that will be a large driver to the brand growth. The other thing that we're seeing is as we've launched new SKUs throughout the year, we're seeing a very good receptivity of broadening the shelf, right? So versus the more doors, we're broadening the shelf in the accounts that we're in, and that's driving significant CPG growth for us as well.

[Operator Instructions] Your next question comes from Aaron Edelheit with Mindset Capital.

I wanted to ask strategically, when you think about your current greenhouses versus the new state-of-the-art facility, can you tell me just in terms of quality and the type of cannabis, like where you expect the new greenhouse to kind of fit in the landscape of outdoor greenhouse and indoor? Because I think that you're aiming towards higher than greenhouse. I just wonder if you could give some color on what you -- where you expect that flower to position in the market.