2017 LEGAL CANNABIS INDUSTRY

STATE MARKET UPDATE

CALIFORNIA

PUBLISHED & PRODUCED BY NEW FRONTIER DATA

 STATE MARKETS
U.S. LEGAL STATES:
UNDERSTANDING
THE COMPLEX STATE
MARKET LANDSCAPE
CHALLENGES OF CANNABIS
STRATEGIC PLANNING
C annabis is a dynamic, fast-moving
industry. The dynamic, unpredictable
nature of the industry complicates strategic
planning and resource allocation decisions,
leading to greater uncertainty when com-
pared to other, more developed, industries.
As the forecast period lengthens in cannabis,
the ability to accurately predict performance
decreases dramatically. This inability to
predict performance causes investors and
industry operators to take uncomfortable
risks, and the risk of underperformance
(or growth based on a weak foundation)
decreases investor confidence and threatens
the growth of the industry.
There are several factors that contribute
to the uncertainty in the cannabis industry.
The three major markets for cannabis —
medical, adult use, and ancillary — often
overlap, making the market more difficult
to navigate, and combined with the rapid
© 2017 NEW FRONTIER DATA
regulatory changes of the industry, make
properly evaluating opportunities difficult.
When operators must constantly adjust to
new regulations and policies, it is difficult
to establish industry best practices and
determine what methods are most suc-
cessful. It is not uncommon for businesses
to have to change and adjust business
strategies on a frequent basis. The upside
of this is that cannabis businesses are very
nimble practitioners.
Another contributing factor that compli-
cates strategic planning and forecasting is
the lack of proper business infrastructure,
particularly the inability to access financial
services. Due to the federal prohibition
on cannabis, banks are hesitant and often
unwilling to work with cannabis businesses.
This creates major issues for operators and
can lead to lost margin and revenue. These
factors necessitate more sophisticated data
and analytics to stay ahead in the industry.
THE DEARTH OF DATA DRIVES
RELIANCE ON INTUITION
AND ASSUMPTIONS
The cannabis industry’s complex nature calls
for highly sophisticated data, the lack of
which has proven to be one of the major
1
 STATE MARKETS

MA RKET DATA CONSID E R E D H I G H LY I M P O R TA N T BY CA N N A BI S

EXEC UT IV ES IS USUAL LY OF LOW QU ALI TY

80%
OF HIGH IMPORTANCE

70%
CONSIDER THIS DATA

60%

50%

40%

30%

20%

10%

0%
0% 20% 40% 60% 80% 100%
CONSIDER THIS DATA
HIGH QUALITY

˜ Addressable Market Size ˜ Macroeconomic Data ˜ Distribution/Channel

Partner Financials
˜ Market Share ˜ Customer Satisfaction
˜ Competitive Intelligence ˜ Customer Preferences ˜ Regulatory Information

limiting factors in industry growth, as entre- STRATEGIC PLANNING IN THE

preneurs are forced to rely heavily on their
own intuitions and assumptions. While more
developed industries are able to leverage
historical data and plan accordingly, in the
cannabis industry, at both the operational
and policy making levels, minor changes
in underlying assumptions can drastically
change projections and alter decision-mak-
ing, especially when underlying assumptions
are based on low-quality data.
EMERGING MARKETS OF CANNABIS
The cannabis industry is ripe with opportu-
nities as more states make the decision to
legalize cannabis and set up new markets.
Operators and investors are looking for
methodologies and new approaches
to properly vet these opportunities and
maximize their profits and ROI. Potential
markets for entry must be prioritized so

2 2017 CANNABIS INDUSTRY ANNUAL REPORT


that resources can be allocated to those
opportunities with the highest potential for
return of capital.
Clear and complete data, including quan-
titative and qualitative measures, are
needed to enable effective vetting of the
opportunities. Given the nature of often
sub-optimal data in the cannabis industry,
New Frontier Data has worked to develop
a solution to allow operators and investors
to properly prioritize markets and allocate
scarce resources.
© 2017 NEW FRONTIER DATA
STATE MARKETS
MARKET
PRIORITIZATION
New Frontier Data has developed a
methodology that allows owners and
operators to simultaneously compare/
contrast all state markets, measured
through two key metrics:
1. MARKET GROWTH
Five-year projected Compounded Annual
Growth Rate (CAGR) of total cannabis
market size.
2. NEW FRONTIER BUSINESS
ENVIRONMENT SCORE
Index-based on weighted aggregated
scores of 5 separate quantitative/qualita-
tive variables.
I. Dispensary Density (20%): Total
population divided by number
of allowable dispensaries at
maximum regulatory capacity
II. Average Household Income (25%):
Average household income, $.U.S.
III. Unemployment Rate (15%):
Total state unemployment, %
IV. Consumer Population Growth
(10%): Population aged 15-35, %
V. Regulatory Burden (30%): New
Frontier Data index ranking of regu-
latory burden based on barriers/costs
to entry, taxation policies, and more
3
 STATE MARKETS

The NFD Business Environment Score
is a composite score based upon several
key indicators, and these metrics are
used as inputs to a proprietary model to
determine the overall favorability of the
cannabis business environment for a stan-
dard operator in each state. The market
growth score is determined by comparing
the CAGR of a particular market with
the nationwide average growth rate for
cannabis markets.
N OTE : The market prioritization output
hinges on the New Frontier Data Business
Environment Score. This proprietary new
metric allows our analysts and clients to
determine how favorable a given region will
be to the cannabis industry. The evaluation of
the business environment relies on qualitative
assessments supported by quantitative data.
By quantifying regulatory burden and using
it as an input into the algorithm along with
economic and census data, the Business Envi-
ronment Score can be used as an objective
tool to make more effective decision-making.

GR OWT H IN T HE C ON T E X T OF BU SI N ESSES E N VI R ON M E N T

SLOW BUT STEADY STAR PERFORMERS

o
rad

Oregon Nevada
lo
Co

Alaska Maine
BUSINESS ENVIRONMENT

Michigan California
Massachusetts
Illinois
Montana
Washington

New Mexico Florida

Arizona Rhode Island New Hampshire Hawaii
Vermont
Delaware
Connecticut Washington D.C.

New York
New Jersey Minnesota
FALLING BEHIND CHALLENGING GROWTH

GROWTH

4 2017 CANNABIS INDUSTRY ANNUAL REPORT

 STATE MARKETS

CALIFORNIA MARKET OUTLOOK

California is in the process of implementing

major changes to its cannabis laws that will
have significant implications for current
operators and for those seeking to enter
the market, including new license cate-
gories, investor constraints, and product
testing requirements. The passage of the
Medical Cannabis Regulation and Safety
Act (MCRSA) in late 2015 was an effort
NFD Business to finally bring regulatory control to the
Environment Score
67
country’s oldest and most loosely regulated
Medical Market Legalized in 1996 medical cannabis program, and with Cal-
ifornia voters legalizing cannabis for adult
Adult Use Market Legalized in 2016
use in November 2016 (AUMA), the state

CA LIFORN IA ’S LEGA L CAN N ABI S M AR KE T

$8
2018-2025 CAGR
$7 12% $6.46 $6.54 $6.59
$6.30 $6.37
$6 $5.62

$5 $4.65
BILLIONS

$4 $3.79

$3 $2.69 $2.76

$2

$1

$0
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
˜ Adult Use ˜ Medical

© 2017 NEW FRONTIER DATA 5

 STATE MARKETS

CALIFORNIA’S SHARE OF THE TOTAL U.S. LEGAL CANNABIS MARKET

50%

40.9%
40%
34.5% 34.9% 34.7% 35.1% 34.3%
32.1%
30.1%
30% 28.6% 27.4%

20%

10%

0%
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

˜ Adult Use ˜ Medical

is poised to house both the largest regulated
medical and adult use cannabis markets in
the country. MCRSA and AUMA were
each set to be implemented by January
2018, but the industry is facing opposition
from individual municipalities and a flourish-
ing black market. Many program details are
still undecided, and adult use sales will likely
not begin until mid-2018 at the earliest as
lawmakers and regulators work together to
implement a statewide plan.
Legal cannabis sales in California are pro-
jected to reach $2.8 billion in 2017 and,
supported by the activation of a regulated
adult use market, annual sales are projected
to grow at a compound annual rate (CAGR)
of 12% over the following eight years to
reach an estimated $6.6 billion by 2025.
Medical cannabis sales in California are
projected to account for 35% of all legal
cannabis sales in the country in 2017.
Despite activating adult use sales in 2018,
the state’s share will decrease slightly over
time as many other newly legal states begin
to roll out medical and adult use programs.
Still, with a population of more than 39
million, and with geographic regions in the
northern part of the state that present

6 2017 CANNABIS INDUSTRY ANNUAL REPORT


climatic conditions ideal for cultivation,
California will remain the most dominant
player in the country’s cannabis industry.
By 2025, the state is projected to account
for more than a quarter (27.4%) of all legal
cannabis sales in the country.
MEDICAL MARKET
Qualifying Conditions
^^ Anorexia
^^ Any Debilitating Illness Deemed
Appropriate by a Physician
^^ Arthritis
^^ Cachexia/Wasting syndrome
^^ Cancer
^^ Chronic Pain
^^ Epilepsy
^^ Glaucoma
^^ HIV or AIDS
^^ Intractable Spasticity
^^ Migraine
^^ Multiple Sclerosis
^^ Nausea
^^ Persistent Muscle Spasms
^^ Seizures
California has America’s longest history
of medical cannabis sales - the first (albeit
unregulated) dispensary in the United
States opened in the San Francisco Bay
area in 1992, and operation of the San
Francisco Cannabis Buyers Club helped
set the stage for the Golden State to
© 2017 NEW FRONTIER DATA
STATE MARKETS
become the nation’s first to fully legalize
medical cannabis through Prop. 215 (the
Compassionate Use Act) in 1996. The
original law allowed doctors to recom-
mend cannabis for serious conditions, and
patients were permitted to use, possess,
and grow cannabis themselves or designate
caregivers to assist them, though a regu-
latory framework was not developed until
much later. Absent any unified regulatory
oversight, widely varied market practices
emerged across the state, and patients
and businesses alike faced frequent raids
by federal and state authorities.
On September 11, 2015, the California Leg-
islature passed a series of bills that together
would establish California’s first statewide
licensing system for medical cannabis
businesses. In October 2015, Governor
Jerry Brown signed the Medical Cannabis
Regulation and Safety Act (MCRSA) into
law. Primary authority was given to the
Department of Consumer Affairs, where a
new bureau (the Bureau of Medical Mari-
juana Regulation [BMMR]) will oversee the
program and share the licensing authority
for various types of businesses with the
state’s departments of Public Health, and
Food and Agriculture, respectively.
One of the key issues making it difficult for
the state to closely monitor the program over
the years has been the lack of centralized
data and reporting, in part due to voluntary
7
 STATE MARKETS

LICENSE TYPES UNDER T H E R EG U L AT I O N

& CON T ROL OF T HE B UR E AU

LICENSE TYPE DESCRIPTION

Cultivation: Specialty outdoor. Up to 5,000 square feet of

T YPE 1 canopy, or up to 50 noncontiguous plants. (Small)

T YPE 1A Cultivation: Specialty indoor, Up to 5,000 square feet. (Small)

T YPE 1B Cultivation: Specialty mixed-light. Using exclusively artificial lighting. (Small)

Cultivation: outdoor, up to 5,000 square feet using a

T YPE 2 combination of artificial and natural lighting. (Small)

T YPE 2A Cultivation: Indoor, 5,001 – 10,000 square feet. (Small)

T YPE 2B Cultivation: Mixed – light, 5,001 – 10,000 square feet. (Small)

T YPE 3 Cultivation: Outdoor, 10,001 square feet – 1 acre. (Medium)

T YPE 3A Cultivation: Indoor, 10,001 – 22,000 square feet. (Medium)

T YPE 3B Cultivation: Mixed – light, 10,001 – 22,000 square feet. (Medium)

T YPE 4 Cultivation: Nursery.

T YPE 6 Manufacturer 1: for products not using volatile solvents.

T YPE 7 Manufacturer 2: for products using volatile solvents.

T YPE 8 Testing

T YPE 10 Dispensary: General.

T YPE 10A Dispensary: No more than three retail sites.

T YPE 11 Distribution

T YPE 12 Transporter

8 2017 CANNABIS INDUSTRY ANNUAL REPORT


patient registration. The state is acutely
aware of the challenges created by previous
approaches to cannabis regulation, and the
recent frameworks adopted for the medical
market make it evident that California is
going to have one of the most compre-
hensive and complex licensing systems for
medical cannabis in the country.
NOTE: MCRSA took effect in January 2016,
and the government has until Jan. 1, 2018,
to develop statewide rules. Licenses under
MCRSA will not be issued until 2018 at ear-
liest. The rollout of the newly regulated MMJ
industry will set the tone for the implementation
of the adult use industry under AUMA.
The most notable changes to the state’s
medical program under MCRSA include:
ĵ New License Classes
ĵ Ability for Businesses to Operate
Under a For-Profit Status
ĵ New Requirements for
Testing and Labeling
ĵ Development of Delivery Services
Local Approval
Under MCRSA, localities can determine
their own medical cannabis regulations.
The act initially created 17 license catego-
ries to guide the regulated medical market
until the statewide adult use regulations are
implemented. Vertical integration will not
© 2017 NEW FRONTIER DATA
STATE MARKETS
be permitted, unless an existing vertically
integrated business was grandfathered
in before 2015 (the licensing structure
is subject to change once AUMA is fully
implemented, depending on the new adult
use rules).
For now, many aspiring cannabis business
owners have made efforts to obtain a
license at the local level, with hopes of
ultimately obtaining a state medical or
adult use license once regulations are
cemented. Unfortunately, many have
been met with disappointment as local
licenses are limited, and many municipal-
ities are still banning businesses.
NOTE: Local business licenses might ulti-
mately have different requirements than the
statewide medical and adult use permits, which
will create additional regulatory complexity
and compliance risks for businesses going
through the permitting process.
ADULT USE MARKET
In November 2016, 57% of Californians
voted for Proposition 64, the Adult Use
Marijuana Act (AUMA), to establish a
regulated adult use program in the nation’s
most populous state. Beyond laying the
groundwork for a statewide regulatory
system, AUMA allows for cultivation of
cannabis for personal use, and creates two
cannabis business taxes: one on cultivation,
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 STATE MARKETS

A DULT USE LICEN SIN G F R AM E WOR K

ADULT USE
DESCRIPTION
LICENSE TYPE
Cultivation: Specialty outdoor. Up to 5,000 square feet of
T YPE 1 canopy, or up to 50 noncontiguous plants. (Small)

T YPE 1A Cultivation: Specialty indoor, Up to 5,000 square feet. (Small)

T YPE 1B Cultivation: Specialty mixed-light. Using exclusively artificial lighting. (Small)

Cultivation: Outdoor, up to 5,000 square feet using a

T YPE 2 combination of artificial and natural lighting. (Small)

T YPE 2A Cultivation: Indoor, 5,001 – 10,000 square feet. (Small)

T YPE 2B Cultivation: Mixed – light, 5,001 – 10,000 square feet. (Small)

T YPE 3 Cultivation: Outdoor, 10,001 square feet – 1 acre. (Medium)

T YPE 3A Cultivation: Indoor, 10,001 – 22,000 square feet. (Medium)

T YPE 3B Cultivation: Mixed – light, 10,001 – 22,000 square feet. (Medium)

T YPE 4 Cultivation: Nursery.

T YPE 5 Cultivation: Outdoor, Greater than 1 acre. (Large)

T YPE 5A Cultivation: Indoor, Greater than 22,000 square feet. (Large)

T YPE 5B Cultivation: Mixed – light, Greater than 22,000 square feet. (Large)

T YPE 6 Manufacturer 1: for products not using volatile solvents.

T YPE 7 Manufacturer 2: for products using volatile solvents.

T YPE 8 Testing

T YPE 10 Dispensary: Retailer.

T YPE 11 Distributor

T YPE 12 Microbusiness

10 2017 CANNABIS INDUSTRY ANNUAL REPORT


and another on retail sales. The state has
announced that it will begin accepting
applications for adult use cannabis licenses
in January 2018, although sales will not
legally begin or be taxed until mid-2018 at
the very earliest.
The regulations under AUMA will closely
mirror those of MCRSA , with both
subject to change as implementation gets
underway. Building off the licenses defined
under MCRSA, the adult use law would
create three new cultivation licenses for
“large” cultivators, though in an effort to
allow smaller producers time to establish
their operations, those large cultivator
licenses will not be issued until 2023, five
years after the program’s implementation.
Adult use retail sales will be taxed at 15%,
higher than Colorado’s 10% rate, yet sig-
nificantly lower than the 37% tax levied in
Washington. Additionally, cultivators will be
charged a flat rate of $9.25 per ounce of
flower produced, and $2.75 per ounce of
trim produced.
Despite some operational challenges
in the forms of local opposition, a deeply
entrenched illicit market, and a regulatory
structure still in development, there remain
sizable opportunities for entrepreneurs in
the state – both for operators that touch the
plant (such as cultivators, retailers and man-
ufacturers), as well as for ancillary businesses.
© 2017 NEW FRONTIER DATA
STATE MARKETS
TRENDS & ANALYSIS
Global Impacts of Adult Use Legalization
Were California an independent country, it
would represent the world’s eighth-largest
economy. In addition to revenue genera-
tion, adult use legalization in California will
help reshape the national and global debate
about cannabis law reform. The state’s acti-
vation of legal adult use sales is projected
to inject over $1 billion into the market in
the first year of operation, making cannabis
an important engine of growth in the U.S.
economy. Meanwhile, California should
provide rich case studies surrounding the
economic impact of the industry at large.
Beyond the jobs created and taxes paid by
businesses that grow and touch the plant,
the ancillary products and services that
serve the industry, from agricultural supplies
to real estate and technology, will highlight
the extent to which adult use legalization
can be a catalyst for new economic growth
in innovative ways.
Cannabis Research
California is also set to become a leading
incubator for cannabis research: Under
AUMA, 10% of cannabis sales tax receipts
will be spent on drug abuse research, and
an additional 10% will focus on cannabis
research. With the industry projected
to raise as much as $1 billion annually in
tax revenues for the state by 2025, the
funding resources for the state’s drug
11
 STATE MARKETS

abuse and cannabis research initiatives will
dramatically outpace those of any other
state in the country, establishing California
as a global center for cannabis science and
policy research.
Out-of-State Diversion
Given its number of cultivators, a history of
loose regulation, and a strong home-culti-
vation market, California is a prime source
for significant diversion of excess canna-
bis through the illicit market into other
states, causing tension within the market,
especially as it regards federal law enforce-
ment and state industry stakeholders. The
implementation of stronger regulations,
including testing requirements and a seed-
to-sale system, will likely help stem illicit
market trafficking; nevertheless, efforts
toward preventing out-of-state diversion
will continue be a major practical concern
as a large percentage of California’s aspir-
ing cultivators are not expected to make
the transition into the formally regulated
legal market due to compliance costs and
regulatory hurdles.
failed to gather more than 36% approval.
Among other provisions, Prop M repealed
a previous ordinance that would have
capped the number of dispensaries oper-
ating within the city limits to just 135 (in
a city with a population of 4 million). A
new city licensing system is vital for Los
Angeles cannabis companies to comply
with upcoming state regulations, which,
as of January 2018, will require a local
permit as a precursor for obtaining any
state business license.
NOTE: Prop M also sets a September 30
deadline for L.A.’s city council to pass a new
regulatory structure for the industry, autho-
rizes new and steeper fines for unlicensed
cannabis businesses, and establishes sales tax
rates for different types of cannabis-related
business licenses.

Crucial Ballot Measure Passes in L.A.

The Los Angeles cannabis industry took
an important step in March 2017 with
the passage of Proposition M , a city
ballot measure setting the stage for a
new municipal permitting system. Prop
M passed with 79% of the vote, while a
competing ballot measure (Initiative N)

12 2017 CANNABIS INDUSTRY ANNUAL REPORT