Insights in the New York Cannabis Market

EA:
Thanks, Kaelan. Let's get right into New York State. How many different licenses are available in New York State?

KC:
Well, it depends. Right now there's only two essentially classes of licensure. One is on the production side and that includes a proser license and a cultivator license. And the other one is on the retail side, and that's the card license. Now, neither of them are actually available. Those are conditional licenses, meaning you had to meet a certain amount of conditions in order to receive them. So the first two licenses I mentioned, the cultivation license and the processing license. You had to have already been a licensed grower or processor for hemp in the state of New York in order to get them. That was opened last year and then closed.

And then with CARD, there's a couple of different ways you could qualify. One was if you had a conviction, a cannabis conviction in the State of New York, or you worked as a nonprofit with those type of individuals called just involved individuals, and you had to have been operating in profitable business. That application window opened last year, the end of the summer, early fall, and that also closed. So right now there's no licenses available. When they open up the general application round, there'll be nine licenses available.

EA:
And what are those nine? Can you just tell everyone what those nine would be?

KC:
Absolutely. Yeah. So it's nursery cultivation, processing distributor, retail, dispensary, onsite consumption, delivery, and then also the CARD and the AUCC and AUCPs.

EA:
And how does this differ from other states and what other states have done?

KC:
Well, definitely giving the first 280 some production licenses to the hemp industry or participants in the hemp industry is definitely something that has never been done before. And on the retail side, no state has also decided to only give retail licenses to those who have a conviction for cannabis. And the reason they did that is because the state essentially made a policy that said that they harmed individuals and communities by prohibiting cannabis for so long, and that those individuals and communities should be first to be essentially the harm should be repaired for those individuals.

EA:
You talked about CARD licenses, which again are conditional adult use, retail dispensary licenses, and currently there's a lawsuit going on that's preventing the opening of new dispensaries. Was that lawsuit unexpected? And how do you think this will ultimately resolve itself?

KC:
Yeah, I don't think it was unexpected for most people, most legal observers or even the state of New York. The fact of the matter is that most social equity programs are litigated, but this one had definitely some vulnerabilities. This is actually the third lawsuit that has been brought against the program, the first one being settled, Variscite case challenges constitutionality of Dormant Commerce Clause.

And now this current one, which has actually enjoined all licensing surrounding card in the state of New York. This is basically, there's a portion of the law that says all applications need to open at the same time. They didn't do that, as we've already discussed. And so now they're defending that from the lawsuit. So not unexpected at all. And how it will resolve itself, it's unclear. The judge has made it pretty clear that he finds the program most likely to be illegal. And so right now there's about 260 some odd license holders, provisional license holders, who are in a state of limbo and don't really know how they can advance their license to a full licensure.

EA:
So as of today, who can sell THC products in New York State?

KC:
Well, there's 22 licensed retailers in the state of New York. Not all of them are licensed as a retail dispensary, thinking of like a brick and mortar. I think there's like four of them who are just temporary delivery only. So they're just operating a delivery business out of a non-store front retail essentially. So it's pretty small. It's a pretty small amount of license.

Now there is, like I said, close to 400 some odd license licenses on the retail side. On the retail dispensary side, they cannot move forward with licensure, meaning that they have this provisional license that says that if they met certain requirements that they can get a full licensure. But the judge has not allowed them to move forward or not allowed the OCM to continue processing those applications why the case plays itself out. So those licenses ultimately may be invalidated, but there's no path for them to actually get a full licensure and be able to sell THC products in New York.

EA:
New York State currently has no license cap, meaning that there's no limited number of licenses that can be issued. How different is that from other states, particularly those in close proximity to New York? Do you think this is a good approach or whether that needs to change?

KC:
Well, I think it's important to note that while there's no written license cap, the way they've already operated has capped licenses. There's only a certain amount of people who could qualify for a card license, a retail license and then they only issued a small amount of them every month at a board meeting. So while there is no cap, there is the ability for the state to make an application window a finite amount of time. So if you didn't apply within that window, you wouldn't be able to afterwards. And they also have an ability to approve or reject based on how that license holder may affect the general market, so if they've already issued a lot of them.

So there's a lot of tools for the regulator to in essence cap these licenses, but they're not coming out and saying, "We're going to give a hundred retail licenses and the top scores are going to do." So we've seen that in a lot of other states, not necessarily neighboring states like New Jersey doesn't have a cap and Massachusetts doesn't either. Pennsylvania does for their medical program. But there's a lot of issues with those programs, including basically those who can spend the most amount of money in the application process are usually the winners. And that's not good for the consumer always, and definitely not good for the ability for smaller businesses, entrepreneurs such as that too, to succeed or even enter into the market.

EA:
New York State has a two-tier market structure. Can you explain what that is and why it was put into place?

KC:
Yeah, so the two-tier market structure is similar to what you would call a three-tier market structure, regulatory structure for the marketplace and alcohol. So essentially what it means in New York, they have a two tier market with an asterisk, and I'll explain the asterisk in a second, but what it means in New York is that they've separate the licenses into supply tier and retail tier.

So on the supply tier, you can grow, process, distribute, but you cannot have any interest in a retail license and vice versa. So essentially they're saying that you can pick one side of the fence to the other, but you cannot collaborate on the other side, you cannot have a business interest and you cannot vertically integrate your business. Now the asterisk comes into play because they've issued 10 licenses to medical companies who are able to be vertically integrated and are able to have ownership in some of the largest cultivation and retail. So it's not really a two-tier market, it's two-tier market for most, but not all it. And importantly, the small amount that are able to be vertically integrated also happen to be some of the largest cannabis companies in the world. It's a little bizarre.

Now the other aspect actually I should mention too is that there's a micro business license. I think I forgot that when I was explaining the different licenses that can be vertically integrated, but there's a cap on the amount of cannabis you can grow and you must sell your own products.

EA:
Now, we talked about New York State, we talked a little bit about a CARD license. Forgetting about what happens with the ongoing lawsuit and litigation, what's next for a cardholder? Do they need to obtain a different license?

KC:
Well so the lawsuit notwithstanding, what would happen is if you had gotten your provisional CARD licensee or CARD license, you would then need to convert it through the post-secondary license application, which is really actually a more significant application than the initial one to get you the license. There's a lot of things you have to do including getting insurance and disclosing all of your owners. So in New York State, you have to disclose your ownership all the way that it pierces the corporate veil and all the way to one share essentially. If you have any ownership at all, or even debt, you have to disclose who those people are and who might own the fund or the company that owns the shares.

So you have to go through all those disclosures. You have to secure a site. You have to then have a site plan approved essentially, meaning you have to install security cameras and build the space out to spec and show that to the state. This process is pretty complex. We've actually handled close to 40% of such post-secondary license application processes for retailers in New York. And it takes time. It can take several months potentially.

EA:
You mentioned in your response about alcohol. Are alcohol regulations a starting point for cannabis regulations?

KC:
Well, in New York, I think what happened was is the cannabis law was modeled in a lot of ways after the alcohol, beverage and control law. Specifically when we talk about the tiers, separating the tiers and ownership there, the micro business license where you can be vertically integrated, but you can't be larger than a certain size for your cultivation footprint. There's an analogous license type or licensed types and alcohol in New York State. So in that way, I think so.

However, New York State, while they talk about modeling after the alcohol law, many times they've gone way above and beyond when it comes to packaging, marketing, labeling advertising and their regulations are very strict. Some of the strictest we've seen in the country actually, in terms of what you can market, what you can put on your label, your packaging, where you can market your product. We don't see those regulations in alcohol at all.

Access and alcohol is also very significant. You can get alcohol in tens of thousands of locations throughout the state of New York, including on-premise, at restaurants and bars. So New York City has a long way to go to model if they want to actually model off alcohol. And that first comes with respecting that the consumer wants to be met with cannabis in a form factor that they enjoy at the place where they enjoy it. And so limiting all these places where you can buy and there's 22 in New York State. 22, it's absurd. It's laughable. There's 20 million other people. So we need to get to that point and I think that there needs to be a seismic change in the way the regulators think about this marketplace.

On one hand, they say, "We are legalizing cannabis." They're promoting cannabis production and New York cannabis over the illicit market. But then they're saying that, "We need to keep it from people and we know best." Right now we're battling a lobbyist, and we do, while lobbying on behalf of almost the entire industry, there's a flavor ban that's going to go in effect on vapes that could take up to 30% of all vapes on the market out. Why? Because they feel like adults shouldn't be able to choose the flavor of vape or the aromatic profiles in vapes. It's absurd, right? The list is like, dessert, what is a dessert flavor, right? Concept flavors. So they've gone way overboard and they would be helped and the marketplace would be helped tremendously if they moved closer to alcohol as a framework.

EA:
And let's shift gears for a second. How hard is it to raise capital in this industry these days?

KC:
It's very hard. One major issue and a news event that we saw recently is the rescheduling of cannabis. Right now as it stands, and Eric, I'm sure you've talked about this a lot on the podcast, but 280E makes it so you cannot take standard deductions right off taxes. And so the effective tax rate for some operators are up to 70%. It really blows profitability out the window when you also layer on all these compliance costs and just risk in general with cannabis companies failing across the country.

So capital is in very short supply. Institutional groups are also not part of these capital markets. And so you're really looking at non-traditional lenders. So you're looking at essentially hard money loans when it comes to financing and debt. Interest rates anywhere from 15 to 25%. And also for equity, it's a very limited pool of investors.

EA:
Do you see with your clients more debt these days as opposed to equity?

KC:
Yeah, absolutely. I think even when there is equity investments, it's usually paired with debt. People with capital and firms with capital who are deploying into the space have seen a lot of their investments go by the wayside. And so they are evaluating that risk in adding on premium, and that is one way for them to mitigate some of the risk for them. So yeah, I think that is almost in every single investment conversation that I've seen.

EA:
Now you also mentioned the recent decision or the recent, I guess, suggestion about rescheduling cannabis, and that's pretty new. That's just recent current events. Can you explain a little bit more about that to the group?

KC:
Yeah, it's going to be interesting to see. So essentially the Department of Health and Human Services at the federal level has decided that they're recommending cannabis removed from Schedule I to Schedule III. Now, what's important on the tax side is that section 280E of the Internal Revenue Code specifically lists Schedule I and Schedule II drugs as, and people who traffic and such, it's not being able to take deductions. Those on the Schedule III are not beholden to that. So that's a 280E. So this idea of not being able to take deductions will go away there.

It could also mean a lot of other things in terms of essentially ushering in a new regulatory schema from the FDA, because the FDA does regulate Schedule III drugs. So that will be interesting. I think there's some risk there for the industry as well as the FDA has continued to show that they're really only interested in single molecule compounds and specifically the new drug approval pathway, which is essentially a pharmaceutical track.

And right now, especially here in New York, exist more in the supplement realm. So it'll be interesting to see. Now, the DEA also doesn't have to take the recommendation of HHS, right? They could decide that they, well, "Thank you, but we're actually going to go to Schedule II or leave it right at Schedule I. We'll see, they're all part of the same administration. So you'd think that if Health and Human Services decides to make a recommendation that the DEA is going to fall along with that, but it's definitely good news. It's a step in the right direction. It's not legalization at the federal level, but it is like I said a step in the right direction.

EA:
And how long do you think it'll take before the next step in this process gets taken?

KC:
I think by the end of the year at least we'll have clarity on what is happening, what the DEA decides to do. But it's going to be years before we really see the ramifications of this in terms of FDA oversight.

EA:
Now, we talked a little bit about alcohol. Recently Tilray purchased a number of craft beers. Is this a normal progression for an MSO in the cannabis industry?

KC:
I think in the case of Tilray, I think it's a pivot. I think that they're looking, their cannabis investments and brands are not really been successful at all. Their stock price has really taken a hit. But so what they did is they did purchase a good amount of craft beer brands, as you mentioned. And I really think that's for cashflow to show revenue coming in the door. And that they like that marketplace. In terms of the similarities between craft beverage and cannabis, I think there's a significant amount. They're both CPG products, consumer packaged goods. They're both consumed, I think, in similar settings. Consumer behavior can be somewhat similar. The trends that we've seen in craft beverage, whether it's hard seltzer, ciders, craft beer, explosion of craft beer brands and whatnot, and different line extensions and all this, and small breweries and distilleries and wineries and being destinations. And all these things, I think are similar to where we could see the cannabis industry going.

So as a company, if you're already deploying some of these strategies in cannabis, it could make sense to go to alcohol, but it's very different. It's not the same business at all. There's different regulatory, I don't know what Tilray's plan is, probably to build a portfolio of brands, cannabis brands, beverage brands, et cetera. We did see Constellation Brands their one of the largest alcohol companies in the entire world, which is actually, by the way, based in upstate New York, based in Rochester. They did enter the cannabis space with the purchase of Canopy Growth, which they've written down close to a billion or maybe over a billion dollars worth of their investment in it. So it's really not worked out for them, but definitely people in the alcohol industry are seeing similarities and opportunity in cannabis.

EA:
Kaelan, I'm glad we're speaking to you this month because there's so much that's happened lately in the cannabis industry. One of the things also is the recent decision by MasterCard to kind of depart from the debit card industry as it relates to cannabis. How has that affected the industry?

KC:
Well, I think it's really disappointing. It's another way that it costs dispensaries more money and makes it more difficult for consumers to purchase cannabis. Yeah, there's really no reason for it either. It's an about face. MasterCard's policy has always been that they don't accept cannabis transactions on their network, but they have tolerated it essentially. They've looked the other way and now they're not. And so we've been seeing the amount of declines increase, but not just a MasterCard issue. Banks also are declining some ACH transactions across the board, especially small regional banks.

I think the reality is that the banks do not know how to perform KYC when it comes to cannabis, and they're risk averse. A lot of these banks, especially smaller banks, are risk averse by nature. And so they're very worried about banking and processing transactions. And I think this is just another hurdle. I'm fortunate here in New York to represent Dutchie, which is the largest point of sale provider in the country for cannabis. And so have some experience firsthand in kind of seeing how this has affected it, and definitely interested over the next year or so how ourselves and Dutchie and the entire GR team is going to look at making a better regulatory environment for transactions happening at the retail level.

EA:
Kaelan, my final question, and one I ask a lot of my guests, and I get a wide array of answers. Do you expect federal legalization? And if you do, when?

KC:
It's inevitable. You can't have a product that's doing the type of commerce in the amount of states that you have without the federal government regulating it. So we talk about legalization, we're really talking about regulation because right now, the federal government doesn't regulate it. It's illegal to cross state lines. They could enforce the law, and everyone who's participating in the cannabis industry is violating federal law, obviously. So they have to do something. Now, we're in a period of one of the most dysfunctional periods in American democracy in the history of our country. And so to ask something like, is cannabis legalization going to get done soon is impossible to know and probably not because nothing is getting done right. And we're talking about two or three pieces of legislation that pass in the US Congress every year, two or three.

So obviously there's a very large piece of legislation, with their appropriations, defense, the farm bill has to be passed at some point here. So there will be policies that are attached to these larger omnibus bills that do get us, I think, closer legalization. But if we're talking about the amount of work and restructuring that's going to have to happen at the federal level in order to regulate this industry is significant. And there's also a state's rights concern and issue there where states have developed very unique marketplaces and are those left alone with federal legalization. I think that would be a very interesting question.

And I also think too, and this is very important to note, is that let's say Congress goes back next year and they do pass a bill that legalizes cannabis, we would be years, years away from a regulatory rollout of such. The rulemaking process at the federal level takes years potentially. I think that's important to know.

EA:
Well, thanks for joining me today, Kaelan, and thanks for listening to CannaCast as part of the EisnerAmper podcast series. Visit www.eisneramper.com/cannabis. For more information and podcast. Also, please visit www.castetter, C-A-S-T-E-T-T-E-R.co for more information about the Castetter Cannabis Group and Kaelan. And join us for our next CannaCast podcast, we'll discuss other budding issues. Thank you.

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