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Edited Transcript of RBE.V earnings conference call or presentation 7-Apr-20 9:00pm GMT

·41 min read

Q4 2019 Harvest Health & Recreation Inc Earnings Call Vancouver Jun 2, 2020 (Thomson StreetEvents) -- Edited Transcript of Harvest Health & Recreation Inc earnings conference call or presentation Tuesday, April 7, 2020 at 9:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Christine Hersey Harvest Health & Recreation Inc. - Director of IR * Leo E. Jaschke Harvest Health & Recreation Inc. - CFO * Steven Mathew White Harvest Health & Recreation Inc. - Founder, CEO & Director ================================================================================ Conference Call Participants ================================================================================ * Aaron Thomas Grey Alliance Global Partners, Research Division - MD & Head of Consumer Research * Andrew Samuel Bernstein Kessner William O'Neil + Co., Incorporated - Equity Research Analyst * Graeme Kreindler Eight Capital, Research Division - Principal * Jesse Pytlak Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research * Kenric Saen Tyghe AltaCorp Capital Inc., Research Division - MD of Consumer & Retail and Analyst * Matt Bottomley Canaccord Genuity Corp., Research Division - Analyst * Michael Scott Lavery Piper Sandler & Co., Research Division - Director & Senior Research Analyst * Robert Fagan Stifel Nicolaus Canada Inc., Research Division - Equity Research Analyst of Healthcare * Vivien Nicole Azer Cowen and Company, LLC, Research Division - MD & Senior Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, and welcome to the Harvest Health & Recreation conference call to review fourth quarter and full year 2019 financial and operating results and discuss the company's performance outlook. (Operator Instructions) Today's conference call is being recorded. I would now like to turn your conference over to your host, Christine Hersey, Director, Investor Relations for Harvest. Thank you. You may begin. -------------------------------------------------------------------------------- Christine Hersey, Harvest Health & Recreation Inc. - Director of IR [2] -------------------------------------------------------------------------------- Thank you. Good afternoon, everyone, and welcome to Harvest's Fourth Quarter 2019 Earnings Call. On today's call, our Founder and Chief Executive Officer, Steve White; and Chief Financial Officer, Leo Jaschke. Earlier today, we issued a press release announcing our results for the quarter and year ended December 31, 2019. The press release is available on the company's website and filed with the Canadian Securities Exchange and SEDAR. Before we begin, I'd like to remind you that the comments on today's call will include forward-looking statements, which, by their nature, involve estimates, projections, goals, forecasts and assumptions and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Certain material factors or assumptions were applied in drawing a conclusion or making a forecast in such statements. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law. Additional information about the material factors and assumptions forming the basis of the forward-looking statements and risk factors can be found in the company's filings and press releases with the Canadian Securities Exchange and SEDAR. During today's conference call, Harvest will refer to certain non-IFRS measures that do not have any standardized meaning prescribed by IFRS, such as EBITDA and adjusted EBITDA, which are defined in the earnings press release we issued earlier today. Reconciliation to IFRS measures are contained in the press release and our filings. Please note, all financial information is provided in U.S. dollars, unless otherwise indicated. I'll now turn the call over to Steve White, Harvest's Founder and Chief Executive Officer. Please go ahead. -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [3] -------------------------------------------------------------------------------- Thank you, Christine. Good afternoon, everyone, and thank you for joining us. I appreciate your support and interest in Harvest during this challenging time. Before we review our financial results and recent developments, I'd like to address the ongoing COVID-19 pandemic and begin by thanking our employees for their continued dedication during this crisis. First and foremost, Harvest is committed to the health and well-being of employees, patients, customers and the communities in which we operate. Across the country, local and state governments have determined that all medical support and essential service providers, like Harvest, should remain open to best support patients through this trying time. As a medical provider to patients who rely on our products to help manage various conditions, we have made the decision to continue serving our local communities in this time of need. As we do with all aspects of our business, we've created a plan with contingencies, and now our employees are executing it. We have implemented numerous protocols to improve safety for our employees and patients, including increased cleaning and sanitation of our facilities, offering online ordering, delivery and curbside pickup where applicable, limiting the number of visitors in each retail location and facilitating work from home and other benefits for employees were practical. Across many states, we appreciate the great work elected officials and regulators have done to ensure that necessary operational adjustments are permissible in the communities that we serve. We are actively monitoring guidance from governmental and regulatory bodies as we continue to work to serve our patients and customers while employing best practices. Our management team has worked tirelessly throughout this process, and continues to provide support to all of our stakeholders as the situation continues to unfold. We have refined our business continuity plans to ensure seamless operation at our cultivation and manufacturing facilities. To this point, we have not experienced any significant disruptions to our supply chain, and we continue to work closely with our vendors. We take our responsibilities, as an essential service provider, seriously. And as an organization, we intend to remain operational during this time as long as we can do so safely. I'm confident that our team will continue to meet the challenges presented by this pandemic. Now turning to our company performance specifically. A lot has transpired at Harvest since our last earnings call in November, but we had a plan and we are executing it. Our organization has undergone some material changes that we believe better position the company for success in the long term, including a significant capital raise, allowing us to focus on and execute in our key markets, which includes a shift away from large transformational M&A deals and generally moving quickly to address the deals which were outstanding. And we also have made changes to management and to the Board, which we believe will further support our efforts to operate a sustainable business in whatever market conditions that we may face. First, I'll address the management and Board changes. Since our last call, we've expanded our Board of Directors, adding 2 new Board members, Ana Dutra and Eula Adams, and appointing one of our original Board members, Mark Barnard, as Chairman. In December, we announced the pending appointment of Scott Atkison to the Board and the addition of Daniel Reiner as special adviser to the Board. We expect the collective contributions of these experienced executives who have expertise across many industries, including cannabis, will add significant value to the company over the next year as we continue to build-out in key states and return to profitability. Second, we have stated that as an organization, we've modeled a variety of scenarios related to how we would deploy capital to operationalize the assets acquired over the last 1.5 years. And despite ongoing challenges for the industry and tighter conditions in the capital markets, Harvest secured additional debt and equity capital during the fourth quarter and subsequent to year-end. During the fourth quarter, Harvest raised approximately $94 million in debt through various instruments and exchanged new and existing short-term debt totaling approximately $84 million into the new 3-year senior secured debt facility. At year-end, Harvest had approximately $22.7 million in cash and $211 million in debt. Subsequent to year-end, the company raised $41.3 million of debt, $59 million in equity through a private placement. As part of the private placement, Harvest added long-term strategic shareholders with an interest in the future success of the company. Harvest ended the first quarter of 2020 with approximately $85 million in cash and $250 million in debt. We expect this cash is sufficient to support our debt service and allow the company to invest in key markets: Arizona, Florida, Maryland and Pennsylvania, in 2020, while working toward achieving positive EBITDA. To further demonstrate our clarity of purpose, subsequent to year-end, we made several major announcements with respect to our M&A pipeline. In January, Harvest initiated legal actions seeking termination of the merger agreement with Falcon International and the appointment of a receiver to protect the interest of creditors. Since that time, the proceeding has moved fully into arbitration, and we expect to provide updates on material developments as they are available. Consequently, we are no longer including any contribution from Falcon in our forecasting our strategic planning. In March, we announced the termination of the business combination agreement with Verano Holdings. We were disappointed that we're unable to close the deal with Verano. We have tremendous respect for the company and their entire team, and we hope potentially that we can work with them in the future. As part of the termination of the deal, no breakup fees were owed by either party, and each company is now free to invest in its key markets. Additionally, in March, we filed an arbitration action to compel the completion of a pending acquisition of 6 vertical licenses in Arizona, including 2 open dispensaries from Devine Hunter. We are optimistic that we will complete the transaction pursuant to the agreed-upon terms, further adding to our operations in Arizona. We've also announced and closed several new transactions. In February, we closed the acquisition of Arizona Natural Selections, adding 3 open locations to our retail presence in Arizona. The acquisition included a fourth vertical license, a 55,000-square foot indoor cultivation and processing facility in Phoenix, a 70,000-square foot greenhouse facility in Wilcox, and 322 acres of land with 25-acre zoned for outdoor cultivation in Wilcox. The terms of this deal were not disclosed, however, the deal was largely a fixed share transaction. At mid-March, we also completed another fixed share transaction with the acquisition of Interurban Capital Group, service providers and supporters of cannabis retailer Have a Heart. The Interurban Capital Group assets include direct and indirect licenses in California and Iowa and rights to acquire assets and provide cannabis retail support services for dispensaries in California, Iowa and Washington. When we acquired Interurban, we had a thoughtful but immediate and mutually agreed upon plan regarding how to dispose off nonperforming assets. And we began to execute the plan, it precipitated litigation with some of the former owners and license holders of that organization, even though those same parties were part of the planning process for rationalizing assets. We anticipate and look forward to ultimately prevailing in that litigation. On March 24, we announced the closing of the acquisition of Franklin Labs cultivation and manufacturing facility in Reading, Pennsylvania. Cultivation operations are online, supplying product for our 5 retail locations in Pennsylvania. Manufacturing and processing activities at the facility are expected to commence during the second quarter of 2020. We expect to expand the cultivation operations in 2020, doubling the output to alleviate product supply constraints and improve financial performance within the state. Longer term, we may have the ability to again double the cultivation capacity at the facility to support additional retail locations and market growth. Looking into the future and given the significant opportunity ahead to expand operations and improve overall performance in our key markets, we do not plan to pursue additional large acquisition opportunities in the near term. Under certain circumstances, we may complete opportunistic tuck-in acquisitions that complement our existing operations and contribute to profitability. We remain primarily focused on the development and expansion of our businesses within core markets, Arizona, Florida, Maryland and Pennsylvania. To that end, we have discontinued our partnership with the Asian American Trade Association Council for the distribution of CBD products as well. Turning now to 2019 highlights and achievements. Last year was an important investment year for the company with capital expenditures totaling about $110 million. By year's end, we increased our retail presence to 31 open retail locations in 6 States, up from 10 retail locations in 4 states at the end of 2018. We expanded our cultivation and processing operations in Florida and Maryland and continued to improve our throughput metrics at our facilities in Arizona. In addition, we added to our infrastructure and support teams, providing a foundation for continued growth. As we detailed on our last call, toward the end of 2019, Harvest began to concentrate on operations and expansion in core markets, streamlining the business for greater efficiency and implementing cost controls, designed to realign the expense structure with the revenue growth expected from the core business. Harvest continues to rightsize the infrastructure and expenses to more closely match anticipated growth trajectory in the absence of large acquisitions and tighter conditions in the capital markets. Last week, the company made the difficult decision to recommend shuttering operations in Iowa and Michigan, closing 3 medical retail dispensaries. We constantly evaluate additional adjustments to our organization and operational footprint as we continue to monitor our business in response to changing market conditions. I'd like to provide an overview of our key markets and our planned activities in those states. For our home state of Arizona, Harvest has 14 open retail dispensaries, cultivation facilities in Camp Verde, Phoenix & Wilcox, and processing and manufacturing facilities in Phoenix and Flagstaff. We expect to expand cultivation and processing operations in Arizona and potentially at retail locations, given the strength of current market conditions and potential upside from the possible rollout of adult-use cannabis consumption in 2021. Additional product supply will help stock retail shelves at Harvest locations and enhance margins and financial performance within Arizona. In Florida, investments in cultivation expenses -- expansion, excuse me, investments in cultivation expansion made towards the end of 2019 are beginning to yield greater availability of flower and subsequently higher sales and margins for our 6 open dispensaries there. We expect sales will continue to ramp up as more product is available. As of April 1, a vertical license in Florida allows operators to open unlimited number of retail locations, leaving capital and supply constraints as the primary inhibitors for continued market expansion. We plan to begin another cultivation expansion in 2020, with new product and store openings coming into the market in 2021. In Maryland, we currently have 3 open retail dispensaries and a cultivation and processing facility. We anticipate further expansion of our cultivation and processing operations in 2020 to supply our own retail locations and support overall continued market growth. Given the strength of the market, we would potentially add another retail location in Maryland, reaching the maximum of 4 dispensaries allowed by state regulation. As I mentioned earlier in March, we added cultivation and manufacturing capacity in Pennsylvania through the acquisition of Franklin Labs. We expect this facility will alleviate product supply constraints and enhance financial performance in this growing market. Harvest has 5 retail licenses allowing for up to 15 potential retail locations. We plan to expand the cultivation and manufacturing operations to support additional retail locations in 2020 and 2021. As we highlighted on our last call, we believe that targeted investments in our core markets will result in fast and favorable returns. Expanding existing operations in key states allows us to achieve scale within markets, resulting in greater efficiencies and improved financial performance. We are already realizing some of the benefits from the investments made in key markets in 2019. Given current constraints on capital availability, we believe investing in markets with favorable regulatory frameworks and limited licenses to operate, afford the company the best opportunity to return to profitability in the near term. We remain very optimistic about the long-term trajectory of the industry, and we believe Harvest will navigate the near-term challenges presented by COVID-19 and continue to be a strong operator in the U.S. cannabis industry. I'd like now to turn the call over to Leo, who will discuss our financial results and our guidance. -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [4] -------------------------------------------------------------------------------- Thanks, Steve. For the fourth quarter, revenue was $37.8 million, representing an increase of 14% sequentially and 123% year-over-year. Revenue growth was driven by the addition of new and acquired dispensaries as well as growth in our existing cultivation, manufacturing and retail operations. Gross margin before biological asset adjustments improved sequentially to 42.3%, up from 35% during the third quarter. Sequential gross margin improvement was driven by a more favorable mix and reduced promotional activity. Net loss for the quarter was $88.9 million compared to a loss of $71.1 million during the fourth quarter of 2018. Net loss included noncash charges of $17 million in fixed asset and intangible asset impairments and $35.1 million in contract and other asset impairments. Fourth quarter adjusted EBITDA, excluding the impact of biological asset adjustments, was minus $6.8 million, an improvement compared to third quarter adjusted EBITDA of minus $10.9 million. We initiated cost reductions during the fourth quarter and have continued to lower operating expenses in 2020. For the year 2019, revenue was $116.8 million, representing an increase of 149% year-over-year. The revenue mix for the full year 2019 was 56% retail, 25% wholesale and 19% licensing. Gross margin before biological asset adjustment was 36.1% compared to 52.3% in 2018. Full year adjusted EBITDA, excluding the impact of biological asset adjustments, was minus $34.8 million compared to $7.9 million in 2018. Harvest ended the year with 31 open dispensaries, up from 26 at the end of third quarter. Subsequent to quarter end, we have added 5 retail locations through a combination of organic store openings and acquisitions of operational retail locations in Arizona, Arkansas and Michigan. As of April 3, 2020, Harvest owned and operated or managed 35 retail locations in 7 States, including 14 open dispensaries in Arizona. Harvest owned, operated or managed dispensaries, exclude retail locations serviced through Interurban Capital Group. Turning now to guidance. Given the shift away from large acquisitions, we do not believe pro forma metrics are informative, and we will no longer provide those details. Moving forward, we will only be providing guidance and metrics concerning our core business and assets, which are already owned, operated and/or serviced by Harvest. During the first quarter of 2020, we observed an increase in traffic and average order size beginning in mid-March. Concerns around the spread of COVID-19 drove patients and customers to buy additional product, resulting in increased store traffic and average order size across all regions. We did observed some normalization of sales trends at the end of March with some intermittent spikes in sales, including on the last day of the month. We continue to monitor the impacts of COVID-19 on sales trends. We expect to report first quarter 2020 sequential revenue growth in line with the sequential revenue growth reported for the fourth quarter 2019. Given the confluence of factors impacting consumer behavior in these unprecedented times, we are unable to accurately predict near-term sales trends. The uncertainty introduced by COVID-19 pandemic makes it impossible to provide guidance for the full year 2020 at this time. We hope to have sufficient visibility to provide guidance during our first quarter call expected in May. While we are not providing full year guidance for 2020, we would expect continued revenue growth driven by retail dispensary openings, same-store sales growth and new and expanded cultivation and manufacturing operations. Additionally, we expect continued adjusted EBITDA margin improvement due to increased scale of overhead absorption as well as continued cost reduction efforts. As Steve indicated earlier in the call, we are committed to investing in our key markets as we return to profitability. We remain optimistic about the long-term prospects for our industry and our company. With recent capital additions, we believe Harvest is well positioned to weather the short-term market challenges and emerge as a stronger company. With that, let's open the call to questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Your first question comes from Aaron Grey with Alliance Global Partners. -------------------------------------------------------------------------------- Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [2] -------------------------------------------------------------------------------- First one, I just want to ask is just in terms of the split in terms of revenue you saw in the fourth quarter, could you just give any color between wholesale and retail, how that -- how each grew quarter-over-quarter? If not specific percentage, just kind of some qualitative. And then how you expect that mix to trend going forward? I know that's kind of hard with COVID, but I guess just kind of removing COVID, just kind of more as you roll out the cultivation expansion in retail. That would be helpful. -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [3] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [4] -------------------------------------------------------------------------------- Yes. So we're not going to provide guidance on the future, given the current COVID-19 pandemic. However, our full year, we believe, is representative of the general mix that we expect. So 56% retail, 25% wholesale and 19% licensing. We do have opportunities for retail to continue and expand, and we expect that to be the case. But we also are seeing opportunities on the wholesale side. So I think those numbers will be representative. -------------------------------------------------------------------------------- Aaron Thomas Grey, Alliance Global Partners, Research Division - MD & Head of Consumer Research [5] -------------------------------------------------------------------------------- All right, great. And then just want to touch on Arizona quickly. Obviously, a state where you guys continue to deepen your presence and certainly looks to have a lot of promise as myself and many others believe it's one of the most likely states to legalize adult use in 2020. So just wanted to know if you could give any update in terms of what you're seeing on that ballot initiative. It looks like they do have the signatures, which I think is important because it's been harder to gather those among other states that are looking to legalize. So just any update you see there and then how building a bigger presence now makes it so beneficial for you guys in that state, just given how that ballot is currently set up for existing medical operators? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [6] -------------------------------------------------------------------------------- Thanks, Aaron. Yes. So the requirement in Arizona is that signatures -- a few thousand shy of 240,000 signatures is required. The campaign has collected more than 300,000 signatures to date. The campaign is a party to litigation recently filed in Arizona seeking to allow it and other initiative campaigns to add additional signatures through alternative means because of the stay-at-home orders and the other issues associated with the COVID-19. Now we realize that we have collected more than what is necessary, but there is a certain cushion that the campaign feels comfortable having. So we look to other means to try to achieve the comfort that we are looking for. What that means for existing operators is the Arizona initiative has in it an early application period. So it allows operators who are operating in a good standing with the regulator here in Arizona to apply to receive a rec license. That early application period can start in January. And if that application is complete, a decision on that application must be made within 60 days. So existing operators do expect that in mid- to late March, they should start to receive -- start being able to serve adults, 21 years and older, provided that the initiative passes. The polling continues to look better and better every day. -------------------------------------------------------------------------------- Operator [7] -------------------------------------------------------------------------------- Your next question comes from Robert Fagan with Stifel GMP. -------------------------------------------------------------------------------- Robert Fagan, Stifel Nicolaus Canada Inc., Research Division - Equity Research Analyst of Healthcare [8] -------------------------------------------------------------------------------- I just wanted to highlight the strong gross margin performance in the quarter significantly rebounding from last Q. I'm just wondering how should we think about the trend with that going forward in combination with some of your restructuring on the SG&A side, like, can you give us some visibility into when do you expect to hit breakeven EBITDA levels? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [9] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [10] -------------------------------------------------------------------------------- Robert, good question. So I'll comment on a couple of those. The strong gross margin improvement, we do expect continued margin improvement, especially as we continue to invest in cultivation and are buying less of our product at wholesale market. So we expect that trend to continue. We also expect, as we discussed, continued leverage of our existing overhead and further cost reduction. So implied in that is the expected improvement of EBITDA. We're not going to provide guidance today when we expect to transition to positive EBITDA given the current environment, but we hope to be in a position to provide good guidance on 2020 during our May earnings release. -------------------------------------------------------------------------------- Robert Fagan, Stifel Nicolaus Canada Inc., Research Division - Equity Research Analyst of Healthcare [11] -------------------------------------------------------------------------------- Okay. Okay, good to hear. Next one is just -- I realize you guys aren't going to give an overall pro forma look for the year, given the COVID headwind potentially, but any chance you can give us an idea of what, let's say, Q1 pro forma would have looked like assuming all of your acquisitions in the quarter had closed at the beginning of the quarter? Just to give us an idea of like the revenue power of the platform currently. -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [12] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [13] -------------------------------------------------------------------------------- So Robert, we're not going to provide the pro forma guidance for a few reasons: One is, I think that the fact that we are not pursuing those transactions is a good indication that it's not a factor for us going forward; second, I think what we believe is more useful for the company is to report results of what we operate today and what we -- ultimately, what we expect to be doing in May is providing guidance on how what I would call that core Harvest economics looks going into the future. So we're not going to provide pro forma information on this call. -------------------------------------------------------------------------------- Robert Fagan, Stifel Nicolaus Canada Inc., Research Division - Equity Research Analyst of Healthcare [14] -------------------------------------------------------------------------------- Okay. Last quick one and I'll get in the queue is, I appreciate the commentary around how the store traffic and order size have responded to the initial onset of COVID. Any chance you can give us Arizona specific kind of data points that you could talk to in terms of what kind of growth you saw in the end of March? And if that's kind of continuing or going back to normal? And if I had to choose another market that I'd love to hear about, it would be Maryland, but primarily Arizona on the sales trend through the kind of end of March into April? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [15] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [16] -------------------------------------------------------------------------------- Yes. So the Arizona markets, I would say is -- given that it is the bulk of our retail locations, it's certainly consistent with the guidance that we have given overall for the quarter. And just a reminder on that, we're seeing -- initially, what we saw is an increase in both transaction and average order size. On the initial onset of COVID. As -- I think as we transition to more order online and pick up, there are some -- from safety reasons, there are some increased barriers to customer traffic. And in some stores, we've seen transaction count decline, but overall average order size increased. So it's still early in the process with COVID, but to date, we are tracking reasonably well. -------------------------------------------------------------------------------- Robert Fagan, Stifel Nicolaus Canada Inc., Research Division - Equity Research Analyst of Healthcare [17] -------------------------------------------------------------------------------- Okay. So not the material decreases post the surge that we've all seen across the -- most of the U.S.? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [18] -------------------------------------------------------------------------------- We definitely saw a short-term increase and a short-term decrease. But if we look at our results compared to where we expected to be in versus the longer-term trends versus prior year, we are tracking as we would have hoped prior to the COVID epidemic. -------------------------------------------------------------------------------- Operator [19] -------------------------------------------------------------------------------- Your next question comes from Kenric Tyghe with AltaCorp Capital. -------------------------------------------------------------------------------- Kenric Saen Tyghe, AltaCorp Capital Inc., Research Division - MD of Consumer & Retail and Analyst [20] -------------------------------------------------------------------------------- I wonder if you can provide a little more color on how much of a revenue drag in quarter were some of the supply shortages in Pennsylvania and Florida? And then second part of that question, how comfortable are you with the capacity expansion in Florida and how that's ramping? And could you also be able to provide a little more color on your plans as you referenced to double capacity in Pennsylvania in the year? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [21] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [22] -------------------------------------------------------------------------------- So I would say the supply shortage has definitely impacted us much more in Florida than Pennsylvania, Florida, given the market economics there, where we only can sell what we grow. It has been a very limiting factor for us in the overall store performance. We have 6 stores there today. And we -- in that market right now, we are in the range of about 300 pounds of flower per month. And that's began to come online at the very end of February. So we're seeing sales tick up in Florida. We're seeing the volume of flower passing through those stores tick up, and we're continuing to invest in that market to increase cultivation capacity. In Pennsylvania, we are able to purchase flower in the wholesale market. The overall market itself is still somewhat restricted, so we believe additional capacity will certainly help us grow there. But primarily, although we do expect increase in top line, we think margins will also improve in the Pennsylvania market, given that we will have more capacity per in-house grown flower. We believe it also will support future store openings in the balance of this year. -------------------------------------------------------------------------------- Kenric Saen Tyghe, AltaCorp Capital Inc., Research Division - MD of Consumer & Retail and Analyst [23] -------------------------------------------------------------------------------- And just one follow-up quickly, if I may, on Pennsylvania. How important a piece of your -- of the gross margin expansion in year is Franklin Labs? And is that sort of the one of the biggest drivers or one of the biggest supports for your conviction around further gross margin expansion in the year? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [24] -------------------------------------------------------------------------------- Yes. We expect -- we're very much looking forward to the expected margin improvement, I would say, both from the acquisition of Franklin Labs and how that benefits our Pennsylvania overall business model, but also the incremental cultivation that we already brought online in Florida that will begin benefiting us really kind of March going forward. So a little bit of that we'll see here in Q1. -------------------------------------------------------------------------------- Operator [25] -------------------------------------------------------------------------------- Your next question comes from Michael Lavery with Piper Sandler. -------------------------------------------------------------------------------- Michael Scott Lavery, Piper Sandler & Co., Research Division - Director & Senior Research Analyst [26] -------------------------------------------------------------------------------- I was wondering if you could give a little sense of just what the consumer behavior looks like around the current environment. Obviously, we've seen some stockpiling and then a little bit of a pullback. But are there any key differences by region or by anything demographic or anything that might be interesting in terms of understanding how this may look over the next few months or however along some of the -- in the new environment, it looks like it may last? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [27] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [28] -------------------------------------------------------------------------------- Michael, look, so good question. It is still early, so I want to stress that. And it's unknown what the future impacts could be. But here's what we know to date. That we are -- we definitely saw overall increase in transaction and average order size with the onset of the COVID pandemic. As we began to change some of our operating practices to limit the amount of interaction with our customers and have more order online, more drive-up, more delivery. In some markets, we've seen slight declines in transactions, generally offset by increases in average order size. From a product mix standpoint, I would say the generalization that could be made is we are seeing some slight shift away from vapor products and more into flower or edible products. -------------------------------------------------------------------------------- Michael Scott Lavery, Piper Sandler & Co., Research Division - Director & Senior Research Analyst [29] -------------------------------------------------------------------------------- Okay. That's great. One small one and then just another follow-up. You list your key states, Arizona, Florida, Maryland, Pennsylvania, just curious that those happen to be alphabetical. Is there any hierarchy there? Obviously, Arizona is where you're really concentrated, but maybe more so among the rest, is that in order of importance? How should we just think about some of your push in those other markets? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [30] -------------------------------------------------------------------------------- Yes, Michael, the -- those are listed alphabetically rather than in terms of importance. But each of those markets have unique opportunities in them and they're markets that we have the capital necessary to take advantage of what we are looking to do in those particular markets, but they are just alphabetical. -------------------------------------------------------------------------------- Michael Scott Lavery, Piper Sandler & Co., Research Division - Director & Senior Research Analyst [31] -------------------------------------------------------------------------------- Okay, perfect. Real helpful. And then just my last one. You have added a few stores, if my math is right, I think more later in the quarter. So I understand you're talking about the sequential momentum in 1Q you expect. Can you just maybe give us a sense of what same-store sales looks like? And I guess that's typically a year-over-year measure. I'm not sure whichever way you prefer to think about it, but just some of how the organic growth momentum is? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [32] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [33] -------------------------------------------------------------------------------- Yes. Michael, we're not ready yet to start talking about same-store sales comparisons. What I would tell you that it's certainly positive. But we're also with total of 31 stores at the end of the year and starting the year with only 10 stores. It's still a small data point for us. And so we're not ready to be communicating that publicly yet. -------------------------------------------------------------------------------- Operator [34] -------------------------------------------------------------------------------- Your next question comes from Graeme Kreindler with Eight Capital. -------------------------------------------------------------------------------- Graeme Kreindler, Eight Capital, Research Division - Principal [35] -------------------------------------------------------------------------------- Just a follow-up on Q1, asking the question a little differently with respect to the growth there. With respect to the pro forma results that was asked earlier on the conference call, is there any possibility that we could get what Q1 looked like just for the transactions that have closed being Interurban and Franklin, not particularly concerned with any of the ones that were terminated? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [36] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [37] -------------------------------------------------------------------------------- Yes. Again, by choice, we're choosing not to focus on pro forma results and focus on what our reported results are and what -- and in May, assuming that the visibility through the COVID pandemic has settled down a bit to be able to provide our projections at that time what we foresee our core results to be. So we're not in a position to talk about pro forma results. -------------------------------------------------------------------------------- Graeme Kreindler, Eight Capital, Research Division - Principal [38] -------------------------------------------------------------------------------- Okay. And then shifting gears, when discussing the core markets there and the priorities for capital, can you give any color in terms of what the capital budget looks like for 2020, knowing -- I appreciate getting the cash on hand here, and there's a bit of an uncertain environment. So maybe we could discuss sort of no matter what happens, what sort of dollars will be put in the ground. And then what sort of -- what states and then what the amounts might be in terms of where you have more optionality, depending on how things play out over the coming weeks or months? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [39] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [40] -------------------------------------------------------------------------------- Yes. Graham, so great question. So as for CapEx, we haven't provided specific guidance for 2020 CapEx. However, we have evaluated various scenarios and high-priority projects in our key states. And we do expect our 2020 CapEx to be significantly lower than the $110 million that we spent in 2019. As for the allocation of that CapEx, we do expect a majority of it to be allocated to our priority states, Arizona, Florida, Maryland and PA. -------------------------------------------------------------------------------- Graeme Kreindler, Eight Capital, Research Division - Principal [41] -------------------------------------------------------------------------------- Okay. I appreciate the color there. And then last one before I get back in the queue here. Just to get a better sense of the liquidity position of the company, recently, you did a couple of sale-leaseback transactions. I was wondering if you could share what the value is of the unencumbered real estate within the company right now. -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [42] -------------------------------------------------------------------------------- Yes. So we have -- as we mentioned on the call, we finished with about -- we're about $85 million of cash on hand at the end of Q1, and roughly about $250 million of debt. We do have some additional real estate opportunities that are in the queue. The -- I think that the market for different real estate vehicles is somewhat in flux right now given the COVID endemic. So we are -- we believe there's opportunity there, but we're not counting on those opportunities for our financing through 2020. -------------------------------------------------------------------------------- Graeme Kreindler, Eight Capital, Research Division - Principal [43] -------------------------------------------------------------------------------- Okay. So is it a fair statement to say that given the current -- where the company finds itself right now, there is a pathway where it could operate over the next 12 months with no incremental capital raise? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [44] -------------------------------------------------------------------------------- That is fair to say. -------------------------------------------------------------------------------- Operator [45] -------------------------------------------------------------------------------- Your next question comes from Matt Bottomley with Canaccord Genuity. -------------------------------------------------------------------------------- Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [46] -------------------------------------------------------------------------------- Steve and Leo, just want to go back again to your outlook for Q1, not to be annoying about it. But maybe I'll ask it in a bit of a different way that's easier to craft a response. Given that you don't want to talk about pro forma, and I fully understand that, maybe the sort of guidance of having the sequential growth at around 14%. Can you give any sort of goalpost as to how much of that 14% is existing ops and how much of it is acquisitions that closed subsequent to quarter end? And I imagine the only one of note is ANS. So is there any color you can provide in that sense? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [47] -------------------------------------------------------------------------------- Yes. So the -- so the 14% that we reported in Q4, and we think it will be representative of how we close out Q1, is -- there is -- the AZNS transaction had 3 stores in Arizona. That acquisition was closed for a portion of the quarter. In addition to that, we have the Arkansas store was opened up in Q1. So we have that contributing, and we have the full quarter contribution quarter-over-quarter of stores that were opened in Q4 of last year. So that would be our primarily Pennsylvania, 3 stores in Pennsylvania that opened up in Q4 are contributing factor. So we're not going to -- we won't get into specifics on a state-by-state or a store-by-store or M&A transaction basis, but that will provide a little bit of color where we see the growth coming from. -------------------------------------------------------------------------------- Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [48] -------------------------------------------------------------------------------- So it would be the 4 -- sort of 4 stores for a partial quarter out of your 34 -- 35 stores is kind of what the nonorganic would be? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [49] -------------------------------------------------------------------------------- Correct. -------------------------------------------------------------------------------- Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [50] -------------------------------------------------------------------------------- Okay. Next, I just wanted to get a bit more color. Given that I think it's very beneficial to clearly lay out the 4 markets you're going to be allocating capital to and the ones that are probably more of a depth than a breadth story. Can you maybe just line up the strategic rationale of Have a Heart and how that sort of lines up with the strategy, given that I don't believe they have exposure in any of those 4 key markets? And what that sort of brings to the table? I believe they'll have a full quarter, Q2 is when it will sort of come into play here. -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [51] -------------------------------------------------------------------------------- Matt, the strategy behind the Interurban Capital was largely related to the associated capital raise, one; and two, we saw that with the assets that, that organization had, we saw a path to increasing profitability long term at Harvest. The -- it wasn't true. And remember, when we laid out our 4 key states, if there are opportunities that would allow us to do some other things or allow us to go deeper in some of those key markets, we would take those opportunities even if they may venture us into a state that isn't necessarily part of it. So when we looked at that acquisition, the assets that were in Iowa, for example, were not a key part of that acquisition. But overall, we thought that acquisition made a lot of sense for Harvest and had significant implications for Harvest in the key markets that we mentioned, even though the assets acquired were not there. -------------------------------------------------------------------------------- Matt Bottomley, Canaccord Genuity Corp., Research Division - Analyst [52] -------------------------------------------------------------------------------- Got it. That's helpful. And just a very quick one, and then I'll get back in queue. Are you guys still in the process of selling hemp-derived CBD online? Or is that segment of your business completely on pause right now? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [53] -------------------------------------------------------------------------------- It's not a material part of our business. We're evaluating whether we'll be doing any of that going forward. We've always said that what we do well is we operate THC licenses in limited-license jurisdictions. And that's who we are. So to the extent opportunities arise that are related, we may look at them. But long term, that's not a part of Harvest strategy. -------------------------------------------------------------------------------- Operator [54] -------------------------------------------------------------------------------- Your next question comes from Vivien Azer with Cowen. -------------------------------------------------------------------------------- Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [55] -------------------------------------------------------------------------------- Thank you for the question. Sorry, and not to belabor the point around March trends, but just 2 quick ones for me. Steve, it strikes me that kind of the pace of different states embracing social distancing, like, has not kind of been in lockstep. So states like Maryland and Pennsylvania, which are closer proximity to New York, which is obviously a hotspot relative to Florida. So just in terms of kind of the commentary around the spikes, were you seeing a different cadence by state, depending on when like state and local officials were actually making moves? Or was it more broad-based because every U.S. consumer is watching the same news? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [56] -------------------------------------------------------------------------------- I think it's mostly the latter. We didn't see material differences between particular markets. And so I think people are reacting largely to the news that they're watching and reading on the Internet. -------------------------------------------------------------------------------- Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [57] -------------------------------------------------------------------------------- Got it. Okay. That's perfect. And then just my second question, please. The unfortunate reality is the cannabis operators, which have been deemed essential businesses, are not able to access any of the federal funding, I dare call it stimulus, but any of the business relief that's available. Just any commentary on how the industry is like thinking about that? Is there an opportunity with Phase IV to try to get something done? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [58] -------------------------------------------------------------------------------- So there's always an opportunity. It's really interesting that you see cannabis companies have an opportunity or you see increases in demand around the product. Cannabis companies have an opportunity to be -- increase the number of employees that they have at a time when other food and beverage industries, for example, or hotels are laying people off. But we are restricted in what we could do. We are restricted with access. We are also taxed differently than everybody else, of course. So we are looking at this as an opportunity to have different conversations with people who could effectuate the change necessary to allow cannabis companies to be real drivers of recovery, but to be determined on how successful we are in those discussions. -------------------------------------------------------------------------------- Operator [59] -------------------------------------------------------------------------------- Your next question comes from Andrew Kessner with William O'Neil + Co. -------------------------------------------------------------------------------- Andrew Samuel Bernstein Kessner, William O'Neil + Co., Incorporated - Equity Research Analyst [60] -------------------------------------------------------------------------------- So for Maryland, you mentioned expanding cultivation and processing capacity. Is that mainly because you aren't at scale yet on the cultivation side to supply your 3 stores there with as much of your own product as you'd like? Or is it more driven by your view of the wholesale opportunity in the state? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [61] -------------------------------------------------------------------------------- It's more driven by the wholesale opportunities in the state. -------------------------------------------------------------------------------- Andrew Samuel Bernstein Kessner, William O'Neil + Co., Incorporated - Equity Research Analyst [62] -------------------------------------------------------------------------------- Okay. And then to follow-up on one of the previous questions about consumer trends in the current environment. Are you seeing a significant uptick in demand for delivery orders versus in-store transactions in the areas where you do offer delivery? And if that's the case, would you expect to see any meaningful operating margin impact there? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [63] -------------------------------------------------------------------------------- We don't do -- as an organization, we don't do a lot of delivery. The reason we don't do a lot of delivery is because we have experimented with delivery, and there was a significant impact to operating margins when we did experiment with delivery. So currently, the way that we have adjusted our retail processes, it includes curbside pickup, limiting the number of people in the stores. But we have not gone headlong into delivery at this point and don't expect to, unless something changes. -------------------------------------------------------------------------------- Operator [64] -------------------------------------------------------------------------------- Your next question comes from Jesse Pytlak with Cormark Securities. -------------------------------------------------------------------------------- Jesse Pytlak, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [65] -------------------------------------------------------------------------------- I'm just wondering if you can maybe give some sense of the magnitude of the cost that you are trying to remove from the company. And just when we should expect to see that full benefit? -------------------------------------------------------------------------------- Steven Mathew White, Harvest Health & Recreation Inc. - Founder, CEO & Director [66] -------------------------------------------------------------------------------- Leo? -------------------------------------------------------------------------------- Leo E. Jaschke, Harvest Health & Recreation Inc. - CFO [67] -------------------------------------------------------------------------------- Yes. With our -- the cost reductions, the biggest piece of it had started with our announcement of the reduction in force and restructuring that we did in November of last year. And since then, it's really been about streamlining the operations. So we are looking at costs all throughout the P&L and through every business line. When we expect that to stop, realistically, I think it's going to be an ongoing effort for us, even well beyond after we're EBITDA positive. -------------------------------------------------------------------------------- Operator [68] -------------------------------------------------------------------------------- There are no further questions at this time. This concludes today's conference call. You may now disconnect.