Debra Borchardt
Editors note: This interview has been edited.
Green Market Report Executive Editor Debra Borchardt:
When we look at what’s happening in the hydroponics market, it’s really not just a Hawthorne issue, it’s across the board. All these companies were saying things had slowed down, but that the market was going to get better at the end of the year. We weren’t getting a whole lot of color on what was happening. Is it that certain states were slow to get going? Is it that there was just truly oversupply? There are so many reasons why this slowdown could have happened. What’s happening here?
Chris Hagedorn, Division President of Hawthorne Hydroponics (NYSE: SMG)
It’s not any one specific discrete issue. I think it’s a combination of, and just some really poor timing. So if you look back at the history of cannabis and wholesale cannabis pricing, to the extent that we have a sort of a dependable history on that data, which obviously I think you know is relatively hard to come by in this industry, certainly compared to more normal mainstream and kind of, historically tracked industries
If you look back at the wholesale data, there is kind of a cyclical nature where the wholesale price will get kind of overcooked and that’ll sort of compell a bunch of people to start growing or increase in their capacity that in turn will drive, then you’ll start to see capacity or supply begin to outstrip demand. And then you end up in a trough-like we’re in. So we’re seeing that. hat’s nothing new to the industry. That’s happened every four or five years, as far as we can tell kind of as far back as we can track it.
If you look back over a 10-year period or so, you see it again. It happens in this kind of wave pattern, which is again, not unusual. I think what’s amplified a bit this year is again, it’s a few things. Part of it is oversupply and that’s at the national level. Also, I think we were tracking growth in Oklahoma over the past few years that was triple or quadruple-digit in our business.
We’re seeing our business in Oklahoma grow by a thousand percent quarter over quarter. Obviously, that’s not growth that’s sustainable. I think one of the things that we didn’t count on, because we thought the disruption that this industry saw back in 2018, which was largely in our estimation driven by California’s move from prop 215 to prop 64. We sort of told ourselves, that California is by far, the biggest candidate market. Our biggest market at the time as it was over 50% of our business.
What we did not count on was the shift towards Oklahoma, not only for the legal but for illicit growers as well. That was something that we didn’t fully understand. I think it boils down to a few different things. There was the permissibility of the regulatory market there, which is similar to what we saw in places like Oregon and Washington back in 2018, just a really low barrier to entry, so a lot of growers flowing into the state and setting up their operations. What we really didn’t understand and it’s one of those things, like a lot of things that seems kind of intuitively obvious in hindsight, but at the front end was just something we missed, was the scale of the grows in Oklahoma.
I’m talking large outdoor grows in Oklahoma that covers five or 10 acres, whereas illicit grows in California on a hillside up in Humboldt, it’s an acre or two at most. So these grows in Oklahoma, just the scale of them is kind of in the orders of magnitudes larger. So the amount of cannabis that was flowing into the marketplace was causing wholesale prices to trend in a negative direction. Probably about this time last year we started to say, okay, we’re seeing potential storm clouds on the horizon and sure enough kind of those bore out.
Green Market Report:
So you think that this illicit cannabis was going to all the other markets?
Chris Hagedorn, Hawthorne:
Yeah. I think a ton of that product, whether it was initially grown for the legal market and was diverted, or it was grown from inception for the illicit market, I am firmly a believer that that product has flowed outing nationally and it has crushed the wholesale pricing.
Green Market Report:
We knew a lot of the Oregon illicit product was in New York. That was pretty easy to ask people and was, well anecdotally documented, because that’s the only way you can track any of this is, anecdotally asking people.
Chris Hagedorn, Hawthorne:
T your point, we have the same experience that when one considered hard concrete data is, as I said, hard to come by here, the anecdotal information that we’ve gathered says, “Yeah, the Oklahoma market has been a big source of this.” They’re not alone. California, certainly there were some large newer, large outdoor grows there. California had and we’ve talked about this. I think we’ve talked about it publicly, but if not it’s nothing secret.
Green Market Report:
Well in Oregon, everybody knew Oregon was way oversupplied and they just were selling for pennies on the dollar to just unload product.
Chris Hagedorn, Hawthorne:
Exactly, trying to move product. I think there are other things that have amplified the downturn. So there’s this flood of material. When you look at a state like Michigan, which is our second biggest market for Hawthorne by a pretty good margin. The legislature up there was considering changing the caregiver laws pretty dramatically and I think moving the plant count from like 75 down to like 20 or 25, I don’t have the exact numbers. Now that did not end up taking place. But again, the information that we’ve gathered says there was so much momentum and that it still could happen, but there was so much momentum and noise in the state about putting severe restrictions on the caregiver market there, that a lot of folks just pulled back on investments thinking we’re not going to build new cultivation capacity. We’re just going to kind of slow things until we understand how the market for the caregivers is going to shake out in Michigan. That put a damper on investment, which obviously flows back to us for all the infrastructure items we sell, like lights and dehumidifiers and everything.
Then on top of that, there’s obviously the macro overlay of the federal government that just cannot get off its ass and actually move this issue forward. I think everyone expected with the Democrats controlling kind of all three levels between the White House, Senate, and Congress, that they would seize the opportunity to move this thing forward. They haven’t done it, which is extremely frustrating.
For investors, I think it said, “Look, they’re going to lose at least one side of the house, if not both at the midterms.” We shouldn’t have any faith that the Republicans are going to take this, though honestly, as a sort of disillusioned independent, I don’t understand why either party doesn’t just seize this as a political silver bullet, but they haven’t. So I think at the macro level for kind of institutional level investors, there’s just, there’s no enthusiasm right now because the federal government’s not doing anything to help.
Green Market Report:
Do you think that as New York progresses in its program decision making, there might be opportunities there because I know not so much New Jersey, but definitely New York, they’re trying to really tap into the small grower market. They have these micro licenses that they’re offering, which is kind of appealing to a lot of the smaller people that don’t have big money, like some of these MSOs, some of the legacy people, or do you think that’s just not going to ever really develop into any kind of sizable market?
Chris Hagedorn, Hawthorne:
I do. I think you’re going to see some large-scale cultivators obviously sort of taking a claim for themselves and hopefully doing it right. It’s one of the issues that I’ve had with a lot of kind of large scale. I say this at the risk of upsetting our customers, the large-scale kind of corporate style, MSOs that have not placed an emphasis on quality. So I hope that people kind of learn that lesson and put more of an emphasis on that because I just think it’s better for consumers, and ultimately I think it’ll be better for the businesses and the brands they’re trying to create. As far as the craft scale growers being given an opportunity, I think New York is creating those opportunities not only just for small growers, but specifically for social equity style growers and retailers.
Chris Hagedorn, Hawthorne:
Vermont is another state focused on the small grower. Their mindset is very much supporting smaller craft growers and I think it’s a really great concept they have. Look at a state like Vermont, which is, it’s one of, if not the least populated state, but it punches way above its weight in certain industries, like beer and cheese. Vermont’s got nationally known and kind of beloved and respected beer and cheese brands that you may not be able to buy anywhere outside of Vermont. If you can, it’s only within kind of a few states radius, but they still are kind of nationally renowned. There is an opportunity by clearing a way for smaller, higher-end craft growers to establish that same reputation for cannabis.
I think Massachusetts has actually done a fairly good job. It’s not small growers, but they’ve got some really, really excellent kind of larger-scale in-state operators. So I think there are some states in the Northeast that are doing things right, but it’s such early days.
Green Market Report:
So looking ahead, what do you feel is behind this end-of-year recovery that is being predicted by Hawthorne, and by the other companies that are all kind of saying the same thing?
Chris Hagedorn, Hawthorne:
It’s based on a few things and I hope I continue to tell myself it’s not just based on a sort of desperation, that I need to be true. It’s based on logic and research that, the oversupply because people shut those grows off, that oversupply is only the last so long. We use the beer, the wine analogies a lot. They’re always good in this case. It’s a perishable product and eventually, those kind of backlogs are going to either have to be destroyed. They’ll be sold through, they’ll be converted into concentrates and sold through and eventually, people are going to have to turn their farms on.
So we’re looking at that. We look at just sort of seasonal upticks that we’ve seen on our business historically. You can look at the SMG results to understand even that has been slowed down just by the climate. The weather has just not turned in the way that has implications for our outdoor and even to an extent our greenhouse customers as well. So it’s looking at the oversupply, it’s continuing to talk to retailers, talk to cultivators and just try to keep to the extent that there is a pulse on this industry, kind of one pulse that can tell us how things are. We try to keep our finger on it.
I think we’ve got as much information as anybody in space. The reality is, and this is something I know certainly our analysts and our investors don’t want here. But the reality is that real hard data in this industry is hard to come by. A lot of it’s you mash together anecdote and inference and sort of educated guesses and that’s kind of what we have to operate off of. It’s uncomfortable to operate at this scale and with this much at stake, but that’s kind of where we’re at.
Green Market Report:
As far as actual technology in indoor growing, what would you say is really the next big thing? I’ve heard stuff around like timing, the lights and the grows so that they replicate natural sunrise, sunset things like that. I don’t know if that’s just goofy stuff or is that a thing or really what do you see looking ahead is going to be the next big thing or the hottest?
Chris Hagedorn, Hawthorne:
Yeah, I think we’re going to in continue to see sort of a mass migration away from older style lighting, older kind of high-pressure sodium and ceramic metal lighting to LED. The progression toward LEDs are going to continue and we’ve got a bunch of new LED products in our pipeline that continues to kind of refine and iterate on the technology that we’ve launched. So LEDs are going to continue to be a monster and kind of take over the industry and the stuff that you’re talking about, whether it’s lights that turn on and off and sort of dim themselves on and off. You read about those in Brookstone, those alarm clocks that sort of wake you up, like the sun, plants are not dissimilar in that they like to be woken up kind of gradually as well. So lights that have sunrise, and sunset.
Now we’re also looking at the spectrum that the sun’s thrown off at sunrise when the sun comes up is very different than the spectrum when the sun’s setting or at noon. So lights that where the spectrum shifts throughout the day to mimic what the plants are used to over the course of millions of years of grown in nature. So we’re looking at all those things. I would say at a larger scale, what I’m really excited about and it doesn’t exist in a way that I think it needs to, is just full facility kind of control and sensor packages that really knit things together. I think it’s something without tooting our own horn here too much that we’re kind of uniquely able to provide just because we take such a broad cut at the industry between lights and dehumidification and HVAC and nutrients and everything kind of, we look at the whole picture.
Once you can begin to introduce AI, machine learning to really kind of use data at scale, and there’s a few companies that are starting to do it, but again, they’re doing it in one specific kind of segment of the industry. There’s no one who’s got the breadth to do it all. I think except for us and it’s on us to actually pull that technology together and we’re working on it, but it’s a big undertaking and for us it’s our roots are in bags of dirt and seed and plants.
This is our most ambitious one yet, but I think it’s where the most opportunity is because this is when you start to say, “Hey, we could maybe pull 30, 40% of the energy costs out of these facilities between all the different technologies.”
Green Market Report:
Do you think that has a lot to do with the fact that you guys have invested a ton into R and D like that’s to your point, some of these smaller companies they’re selling the lights, they’re selling the software package they’re selling, oh, we’ve got these lights that work with these tables. But I haven’t really come across that many companies that have taken some of that money that they’ve made and then turned around and put it into R and D to learn.
Chris Hagedorn, Hawthorne:
We have invested heavily in it. That’s part of the corporate DNA and something I’m really proud of our parent company. And when I say our parent company, it has kind of multiple meanings for me because it’s my grandfather and my old man who really drove that business and continued to, that’s a company that’s always invested pretty heavily in R and D. So getting to grow up both sort of from a literal perspective and in a professional sense around a business, that placed a really high premium, the ability to innovate and understand our products and the plants that our products are used on and what our consumers are looking for. That was always kind of in our DNA.
Which I’m super grateful for and we’ve taken the time. Whether it’s the investment up in British Columbia to build out a cannabis-specific facility or to convert former Scott’s Miracle-Gro kind of turf grass research centers in Oregon to growing hemp so that we can understand because, hemp as a proxy crop for cannabis is about as good as it gets short of optimal cannabis, which we to do in Canada. So yeah, we take it seriously and we’ve been able to draft off the fact that SMG before Hawthorne even existed already had a really deep and experienced R and D capability and team. So we were able to build out our own capabilities for the stuff that’s unique to Hawthorne, that technological stuff that Scott’s never did. Then for all of our nutrients and growing medias, we can depend on the capability that already existed at Scott’s.
