Harvest Health & Recreation, Inc. (HRVSF) CEO Steven White on Q3 2020 Results – Earnings Call Transcript

Harvest Health & Recreation, Inc. (OTCQX:HRVSF) Q3 2020 Earnings Conference Call November 10, 2020 5:00 PM ET

Company Participants

Christine Hersey – Director, IR

Steven White – Founder, CEO & Director

Deborah Keeley – CFO

Conference Call Participants

Kenric Tyghe – ATB Capital Markets

Aaron Grey – Alliance Global Partners

Graeme Kreindler – Eight Capital

Andrew Partheniou – Stifel Nicolaus

Pablo Zuanic – Cantor Fitzgerald & Co.

Matt Bottomley – Canaccord Genuity

Russell Stanley – Beacon Securities Limited


Good afternoon, and welcome to the Harvest Health & Recreation conference call to review third quarter 2020 financial and operating results and discuss the company’s performance outlook. [Operator Instructions].

I would now like to turn the conference over to your host, Christine Hersey, Director of Investor Relations for Harvest. Thank you. You may begin.

Christine Hersey

Thank you. Good afternoon, everyone, and welcome to Harvest’s Third Quarter 2020 Earnings Call. On today’s call are Founder and Chief Executive Officer, Steve White; and Chief Financial Officer, Deborah Keeley. Earlier today, we issued a press release announcing our results for the quarter ended September 30, 2020. The press release and a PowerPoint presentation are 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 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 White

Thank you, Christine. Good afternoon, everyone, and thank you for joining us. I appreciate your continued support and interest in Harvest and the opportunity to provide you with an update on our organization. Given the significance of last week’s election results and the potential impacts to both the industry and to Harvest, I’m going to provide some commentary on the election outcomes before reviewing our third quarter results.

And I’d like to start in Arizona. As many of you may be aware, last week, Arizona voters delivered a resounding victory for potential cannabis consumers by voting yes on Prop 207, a ballot initiative to allow and implement recreational cannabis sales here in Arizona. This historic outcome represents another significant milestone in the inevitable march toward the full repeal of prohibition in the United States.

The success of the recreational initiative in Arizona is uniquely significant for several reasons, but I want to focus on one: the Voter Protection Act. The Voter Protection Act, or VPA as it’s often referred, effectively prevents the legislature from altering successful ballot initiatives, which means that the rules and guidelines delineated in the initiative will remain in effect unless superseded by another ballot initiative. This unique feature of Arizona’s constitution informed how we drafted different critical provisions of the recreational initiative, allowing some flexibility where appropriate but ensuring that fundamental aspects of the initiative be enacted as intended.

Let me be very specific here. As an industry, when we evaluate the opportunity for medical and recreational programs across the country, we tend to focus on the revenue that the state is expected to generate. But that only tells part of the story. We typically cannot accurately predict the stability of the regulatory structure or the number of potential competitors long-term in a given market. The stability of the market structure and predictable number of competitors is what makes Arizona unique.

Because the license structure is specifically detailed in the initiative, we have a high level of confidence in our understanding of how licensing will work and the maximum number of potential competitors that can operate unless and until the market structure is changed at the ballot box. And I’ll talk a little more about this later.

The Voter Protection Act is the biggest reason we view Arizona as a market with a stable regulatory structure that affords us higher confidence in the long-term viability of investments. As outlined in Prop 207, existing medical operators may apply for a recreational license on January 19, 2021. The Arizona Department of Health Services will then have 60 days to approve or reject the application, otherwise, it is assumed approved.

Theoretically, this time line may permit recreational cannabis sales at the end of the first quarter of 2021. Let’s be clear, however, that while we have a strong and experienced regulator and a mature medical market, we do not expect the expansion of the cannabis market to include recreational sales to be perfect. As we have seen in other instances where existing medical markets were expanded to include recreational use, we expect that there could be some regulatory delays, logistical constraints or supply shortages in connection with the rollout. But given the maturity and stability of the Arizona medical market, we would expect these hiccups to be relatively short-term and readily addressable in nature.

Similar to other newly operational recreational markets, we expect strong demand. We are confident that the industry in Arizona will be able to adapt and meet the needs of both medical patients and recreational consumers. Harvest has been preparing for the implementation and rollout of recreational cannabis consumption in Arizona and will be ready to serve consumers as soon as allowable. We’ve already begun a significant awareness and marketing campaign designed to boost our company profile and educate potential consumers about the availability of recreational cannabis coming in 2021.

We have increased our own internal production, secured additional product supply and invested in technology and store refurbishments. Our organization is well positioned and ready to welcome recreational consumers while continuing to serve our existing medical patients.

Now a little bit about the market. One conservative economist hired by the campaign to estimate tax revenues forecast that the Arizona cannabis market will reach approximately $2 billion at maturity. For him to be correct, Arizona would have to have lower adoption rates than any other recreational state at maturity. Needless to say, we are more optimistic on the market potential, and we believe that the market will exceed $2 billion at maturity.

The time it takes for the market to reach maturity will depend on several factors, including: first, the timing of initial recreational cannabis sales; second, the ease of implementation for existing operators; third, availability of product to supply market demand; and fourth, the sophistication of the illicit market. In these areas, Arizona compares favorably to previous markets that have expanded to allow recreational sales.

While the size of the market matters, so too does the number of licensed operators. Arizona is unlike other recreational markets in that each license is a fully vertical one, as is the case in the medical market. Existing operators in good standing in the medical market may apply for a recreational license, which means up to 130 recreational license applications may be submitted. In addition, in counties with less than 2 dispensaries, the state may issue additional licenses in order to reach a minimum of 2 licenses per county, adding approximately 10 or so store fronts.

Unlike other dispensaries, those newly permitted locations must remain within the county. At some point in the future, 26 social equity license may also be issued. One way to estimate the expected average performance of the store would be to take the conservative $2 billion total market size and divide it by 166 stores. Based on our view of the market, we have a high degree of confidence that 166 store locations represents a fair approximation of the total retail footprint in the state. Applying those metrics, the average store would realize a little more than $12 million per year in revenue. In practice, of course, some storefronts will underperform or exceed the average revenue generated per store. With the recent acquisition of 3 additional licenses in Arizona, Harvest expects to be operating at least 18 of those stores.

Pending necessary approvals, we plan to serve the recreational market at our existing retail locations. By co-locating medical and recreational sales at our existing locations, we will be able to serve recreational consumers much more quickly, avoid capital expenditures required to construct additional dispensaries and realize greater operating leverage on those incremental recreational sales.

With the exception of the 3 newly acquired licenses, which we plan to use for 3 additional stores, all of our stores are fundamentally ready to serve recreational customers today pending necessary approvals. We will be working closely with the Arizona Department of Health Services, local and municipal agencies and other community officials to position our dispensaries to commence recreational sales as soon as possible. We do expect to provide more details on the development of the Arizona market during our fourth quarter results call in March when we’ll also introduce full year 2021 guidance.

Turning now to the broader election results in the U.S. The election of Joe Biden as U.S. President is a promising development for cannabis reform. However, our optimism for reform is limited by developments in the Senate. As an industry, we must work hard and with a unified voice in our efforts to garner support from electives who come from states that have opted for cannabis reforms. But the Senate leadership, frankly, has not been friendly to our cause in spite of big victories in each and every state that had the option to choose cannabis reform.

Our view on federal reform has not changed. We are confident that we will see federal reform and that it will be significant. The public demands it, as is evidenced by cannabis votes in 5 states this last election cycle. But the timing of that reform is less clear. This also means for us, it’s business as usual. We will continue to build and operate our business, make intelligent investments, increase our revenue and control our costs.

Now turning to third quarter results. Harvest has a plan to return to profitability, and our third quarter results mark continued execution according to that plan. I’ll provide you an update on our continued progress, discuss recent developments and provide an overview of our core markets. Then Deborah will present more detailed financial results and guidance.

Our third quarter results demonstrate improving quarterly trends and underscore the considerable progress we’ve made over the past few quarters. Third quarter sales of $61.6 million represents an 86% increase year-over-year and an 11% increase from the second quarter. Higher revenue sequentially was driven by growth in existing operations in our retail, wholesale and licensing segments. In September, we opened additional retail locations in Phoenix, Arizona and Cranberry Township, Pennsylvania.

Now turning to costs. Over the past year, Harvest has been able to significantly reduce costs and streamline operations, lowering cash operating expenses by more than $30 million on an annualized basis. We are pleased by the progress that we have made and we’ll strive to control costs moving forward as we continue to scale our business and increase revenue. On an absolute basis, revenue and gross profit are increasing, while overhead is decreasing, resulting in higher adjusted EBITDA. Third quarter adjusted EBITDA increased to $10.5 million, up from $4.1 million during the second quarter.

As part of our plan to improve our overall financial performance, we are actively managing our liquidity. Harvest ended the third quarter of 2020 with approximately $63 million in cash and $294 million in debt. We have sufficient capital to service our debt in 2020 and 2021, and we have the flexibility to accelerate or delay capital expenditures as our capital position changes. We will make necessary adjustments to our plan to ensure that we meet our obligations while pursuing profitable growth.

Turning now to recent developments. Since the end of the third quarter, we have opened 2 additional retail locations in Camp Hill and King of Prussia, Pennsylvania. While it has only been a few weeks, we are seeing strong initial results from those locations. On October 2, we terminated the agreement to sell 2 additional California retail assets to Hightimes Holdings for $6 million. As a reminder, the sale of 8 California retail assets was completed in June.

On October 28, 2020, Harvest completed a bought deal financing, raising gross proceeds of approximately CAD 46 million or approximately USD 34.5 million. The company intends to use the proceeds for a combination of purposes, including debt service, capital expenditures and working capital.

On October 30, Harvest completed the purchase and license transfer of THChocolate, including licenses for cannabis and cannabis products manufacturing in Colorado. Consideration paid was immaterial and the terms of the deal were not disclosed.

On November 2, Harvest announced a settlement of ongoing litigation with Devine Holdings. Under the terms of the agreement, Harvest acquired 3 vertical medical licenses in Arizona in exchange for the forgiveness of the outstanding $10.45 million receivable owed to Harvest by Devine Holdings. Harvest will also have the right of first refusal on 4 additional vertical medical licenses in Arizona. We are very pleased with this resolution.

Finally, with respect to the ongoing COVID-19 pandemic, we’ve been able to manage any challenges related to COVID-19, while following CDC guidelines for best practices. All of our facilities have remained online with modified operating procedures to safeguard employees, patients and customers.

We continue to monitor our sales trends are impacted by COVID-19 and its macroeconomic repercussions. As we have highlighted before, part of our strategic plan includes making targeted investments with fast and favorable returns in our core markets. During the 3 months ended September 2020, we spent approximately $4 million on capital expenditures, with the majority of those investments made in Arizona, Florida, Maryland and Pennsylvania.

Our four core markets are medical markets with limited license, regulatory structures, continued patient growth and future potential upside from recreational cannabis consumption. Our home state of Arizona is one of the fastest-growing medical markets in the U.S. and is now obviously poised to allow recreational use as early as the first quarter of 2021. Harvest has the largest retail presence in the state with 15 open retail dispensaries. And with the recent settlement in the case with Devine Holdings, we acquired 3 additional vertical licenses, bringing our total retail presence to 18 locations when fully built up. Those locations are supported by cultivation facilities in Camp Verde, El Mirage, Phoenix and Wilcox and processing manufacturing facilities in Flagstaff and Phoenix. We are expanding indoor cultivation and processing at the Phoenix facility as well as greenhouse cultivation at Wilcox, with new capacity expected to be completed during the first half of 2021.

In Florida, we operate 6 open retail dispensaries, an indoor cultivation and processing facility and a secure outdoor cultivation and processing facility. We are expanding our cultivation capacity with new product and store openings coming into the market in 2021.

Maryland has been a solid limited license medical market for several years. In Maryland, we currently have 3 open retail dispensers and a cultivation and processing facility. Harvest is a net wholesaler in the state of Maryland with strong sales outside of our retail operations.

The Pennsylvania market has experienced rapid growth and remain supply constrained. Harvest currently operates 8 open retail dispensaries in Pennsylvania and a cultivation and processing facility in Reading. Harvest has 5 retail licenses, allowing for up to 15 potential retail locations. We are expanding cultivation and manufacturing operations to alleviate product supply constraints, enhance margins and support the opening of additional retail locations in 2021.

Our focused strategy and commitment to investing in core markets is already contributing to our improved financial results. We will continue to optimize operations while pursuing profitable revenue growth. We are very excited and well positioned to serve the recreational cannabis market in Arizona in 2021. We look forward to demonstrating further progress in our plan to return to profitability over the coming quarters.

I’d now like to turn the call over to Deborah, who will discuss our specific financial results and updated guidance.

Deborah Keeley

Thank you, Steve. Good afternoon, everyone. I’m going to provide an overview of our third quarter financial results and updated guidance for 2020. Please refer to the press release and slide presentation for full detail. We had a great third quarter building upon the momentum from our improved second quarter results. Our strong performance in the third quarter was driven by a combination of revenue growth, cost control and operating leverage.

For the third quarter, revenue was $61.6 million, representing an increase of 86% year-over-year and 11% sequentially. Revenue growth was driven by growth in existing retail and wholesale operations and initial contributions from 2 new retail locations opened in September.

Approximately 85% of our third quarter revenue was derived from our core markets: Arizona, Florida, Maryland and Pennsylvania. Revenue mix during the third quarter was 75% retail, 14% wholesale and 11% licensing and other.

As of November 10, Harvest owned, operated or managed 39 retail locations in 7 states, including 15 open dispensaries in Arizona. Third quarter same-store sales increased by 49% year-over-year for the 16 stores that were opened during both periods. Despite the long operating history for our stores, we are still realizing strong growth in our retail base. For the 35 stores that were opened in both the second and third quarters of 2020, same-store sales increased by 12% sequentially.

During the third quarter, we realized a 16% increase in traffic and a 4% decline in basket size compared to the second quarter. This represents the return to a more normalized pattern as our retail locations were open to in-store visits during the third quarter after COVID-19 safety restrictions were lifted.

Gross margin before biological asset adjustment during the third quarter was 46.6% compared to 35% in the third quarter of 2019 and 42.1% during the second quarter of 2020. The sequential improvement in gross margin in the third quarter was driven by improved margin performance in our wholesale and licensing segments, partly offset by lower gross margins associated with our retail revenue. We remain focused on improving the profitability of our business. And we expect our gross margins will continue to trend upward overall, with some quarterly fluctuations due to mix and market changes.

Third quarter SG&A was down to $21.6 million or 35% of revenue compared to 41% of revenue during the second quarter. We expect SG&A as a percentage of revenue will continue to decline over time as our revenue growth outpaces increases in expenses.

Net loss for the quarter was $2.1 million compared to a net loss of $18.3 million during the second quarter of 2020. Third quarter adjusted EBITDA, excluding the impact of biological asset adjustments, was $10.5 million, an improvement compared to the second quarter adjusted EBITDA of $4.1 million. The sequential improvement was due to a combination of revenue growth, economies of scale and additional reductions in operating expenses. I am so proud that we continue to build momentum in the third quarter, further improving our adjusted EBITDA. We really appreciate all the efforts from our team to improve and grow our business.

Turning now to guidance. We are increasing our 2020 full year revenue target to exceed $225 million up from our prior target of $215 million to $220 million. The magnitude of our full year revenue in excess of $225 million depends on the timing of a number of events and process, including potential divestitures of noncore assets, which may result in a decrease in revenue. The revised target reflects the strong results year-to-date while taking into account recent performance and the inherent lack of visibility given the current macroeconomic environment.

The revenue forecast includes continued growth driven by retail dispensary openings, same-store sales growth and new and expanded cultivation and manufacturing operations. Forecast for 2020 assume no impacts or disruptions that we don’t successfully manage, including those caused by the COVID-19 pandemic.

Harvest ended the third quarter of 2020 with approximately $63 million in cash and $294 million in debt. As of November 16, Harvest had approximately $87 million in available cash. Debt service for the remainder of the year is approximately $15.2 million, which we expect to be offset by incoming capital. We estimate sources of capital between $40 million and $55 million, potentially including new and extended financing arrangements and divestiture of noncore assets.

During the fourth quarter, we already extended the debt maturity of $6.5 million due in October 2020, by 1 year to October 2021. As Steve highlighted, we received approximately $32.4 million in net proceeds from a bought deal financing in October.

Capital expenditures for the remainder of the year are expected to range between $7 million and $15 million in addition to the $21 million spent during the first 9 months of 2020. We are actively managing our liquidity and have sufficient capital to service our debt in 2020 and 2021.

As Steve indicated earlier in the call, we are committed to returning to profitability through a combination of targeted investments, operational efficiencies and scale and cost controls. Over the past few quarters, we have shown considerable progress, and we look forward to building on our recent accomplishments in 2021. We believe Harvest is well positioned, and we are very excited for the opportunity ahead.

With that, let’s open up the call to questions.

Question-and-Answer Session


[Operator Instructions]. Our first question comes from Kenric Tyghe with ATB Capital Markets.

Kenric Tyghe

Steve, congrats on the quarter. Great color on Arizona. I wonder, you spoke to the market at maturity. But certainly, there are a number of industry groups trying to handicap that first year potential revenues. Can you sort of speak to either the reasonableness of the estimates that are out there in the public domain for the first year of RAC sales in Arizona? Or failing that perhaps how we should think about the ramp of RAC sales in year 1, just as a jump off point, please. And then a quick follow-up to that.

Steven White

Sounds good. Thanks, Kenric. The difficulty in answer to that — in answering that question is we don’t know when the RAC sales begin. And so I’ve seen some estimates, and I’d frankly not pay too close attention to them because they’re usually accompanied by a misunderstanding of the Arizona market anyway. What I can say is we do expect a significant expansion of the market in 2021. But the reason we’re not ready to say what year 1 is going to look like is because we don’t know — we can’t determine the precise month in which those RAC sales will begin.

So we’re kind of handicapped. But what we’re hoping to do is that in the next quarterly call, we will have a very good idea of when sales will begin. And at that point, we can give you a good estimate of what our entire organization is going to do in 2021 and have further discussions about the development of the Arizona market. In addition to that, though, I would say that when you look at the maturity curve and you look at what has hindered other states, I listed a number of factors that we’ve seen in other states that cause states to not mature as quickly as they could. Arizona does compare favorably to most every state that we’ve seen add recreational sales to existing cannabis sales.

Kenric Tyghe

That’s great. And just a clarification on Devine, would you expect those stores — those 3 stores to be in operation? Is it a first half ’21 discussion or later? And how should we think about not just bringing on those three, but what would be the triggering event, or how do we think about the other four that you have a first right of refusal on? If you could speak to that as well, please.

Steven White

Yes. So in terms of how quickly we’re able to get those stores online, we’re not providing that information yet because this was a settlement that we just reached. And then we do have some locations in process. But the process of getting those approved, we aren’t far enough along to give you precise time lines about when we’re going to get them open. Understanding how good the market is going to be, obviously as an organization, it’s a high priority of ours to get those open as quickly as possible. In the second half of your question was what — I forgot, I’m sorry, Kenric.

Kenric Tyghe

No, Steve, that was honestly, it was more of a first half ’21 or later so you covered that very nicely. If I could just squeeze one more quick one in before I run and then get back in the queue. Deborah, just with respect to the revenue attribution and the gross margin profile that you generated in quarter, is there a material mix impact that is skewing that gross margin performance in quarter and your expectation that it expands again in the fourth? Or is this really just all boats kind of — or rising tide type of thing across the business? Any incremental color you could give us on if it skewed Pennsylvania or it skews one way or the other would be very useful.

Deborah Keeley

Sure. So we were very pleased with our Q3 margins. And as we’ve talked about in the past, margins are based on product mix, and it may fluctuate quarter-to-quarter. We do not expect to see — we do expect to see continued improvement in our margins as we increase our cultivation and manufacturing capacity in Florida, Pennsylvania and Arizona.


Our next question comes from Aaron Grey with Alliance Global.

Aaron Grey

Congrats on the quarter. So first question for me is also on Arizona but more towards cultivation. So first off, I just want to know if you could provide any color in terms of the cultivation expansion you mentioned for first half 2021. Any color you can provide in terms of how much additional cultivation or square footage would come on with that?

And then secondly, just looking at the market, just considering there’s a few more of the bigger MSOs who are in there, but a lot of mom and pops, how do you think that potentially kind of impacts the ability for operators within the state to expand cultivation to meet the adult-use demand in such a quick fashion?

Steven White

Thanks, Aaron. So here’s how I look at — it’s interesting, we have a lot of conversations about cultivation in Arizona. What I would remind everybody is that because it is a vertical license, it means that — the current market, we have 130 licensees who — and that allows us to have 130 storefronts, but it also allows us to have 130 cultivation facilities in the state of Arizona, a proportion that you don’t see in a lot of places.

Obviously, what that means is, for us, the most important thing to concentrate on is storefronts in the state of Arizona. That being said, we have said that we are a net buyer in the state of Arizona. We are working to increase our existing capacity in the state.

The challenge that we have is when we look at the return on dollars invested in cultivation in Arizona and we compare them to some other states that have shortages of supply. It tends to be true that we would rather allocate those dollars to some of those other states. And so while we do plan on increasing our cultivation capacity in Arizona, it is not one of the highest priorities for the organization in terms of cultivation or, just generally, we don’t think that’s going to impact the market.

In terms of the size of some of the competitors, it’s very interesting because Arizona has a wide variety of business models. They have everybody who has, like us, 18 licenses all the way down through a number of operators with simply one. Some of those operators with one license have concentrated on the wholesale market, both with cultivation, production and manufacturing.

And so they have the ability to compete just like anybody else. And some of those models, if they don’t have extensive retail footprints, that’s really the best place for them to be competitive and see that they can get into — onto the shelves of people with more stores.

So we have seen some of those smaller competitors or people with less licenses, actually expanding their capacity in anticipation of this vote as well.

Aaron Grey

That’s super helpful. And then just turning back to the election, but more on a national federal basis. Just given there’s been a lot of speculation around potential changes to cannabis at the federal level, the Senate still looks like it’ll probably be decided in January, which might kind of impact that. But I do want to kind of take a step back and get your view in terms of how you think about setting up the business longer-term preparing for different scenarios of legalization, particularly as it pertains to potentially building out brands or wholesale business, just given you’ve historically been more focused on retail.

Steven White

Yes. Thank you. It’s a great question. The way we look at it is this is still and is going to be, for the near future, a state-by-state rollout of cannabis opportunities. And when you look at the opportunity set in front of each and every organization in cannabis, that opportunity is dependent upon the particular state in which they operate.

And so we still believe that no matter what changes we do see, ultimately, do see on the federal level, that’s going to be how it plays out. In terms of brands, as we all know, in the end or in the very long term, brands are going to matter and they’re going to matter more than anything else.

I’ve been pretty vocal in saying, I think that it’s a little bit premature to talk about that today because we don’t see a lot of brands who have successfully crossed over a number of different states because we just don’t have enough — we don’t frankly have enough states where they’re able to sell their products to see if that’s actually been effective.

So for us, the strategy is the same. It’s to take a look at how a state rolls out its particular program, examine the regulatory regime and make a plan about how we are going to be best positioned to capitalize on that particular market. That’s the vision that we have. That’s the vision that we’re going to be pursuing over the next couple of years until something very major changes.


Our next question comes from Graeme Kreindler with Eight Capital.

Graeme Kreindler

Steve, I just wanted to follow up on the discussion — or on the previous questions regarding the capacity and bring it full circle with respect to that benchmark you talked about on a potential $12 million per store on average in RAC in Arizona. If you think about some of the other states that have recently gone RAC, it seems like the real key differentiator for its success of driving revenues that are of that average has really been securing that supply and having products on the shelf.

So given what you said to the prior question here, is Harvest anticipating any meaningful supply shortages in the early days of RAC in Arizona? You mentioned that in addition to expanding your own cultivation capacity, you’re working to secure additional sources of supply. So how tight is that market expected to get? And are you doing the work now to make sure that, day one, there’s an excess of supply for Harvest, and maybe the same can’t be said for some of the other players in the Arizona market.

Steven White

It’s a great question, Graeme, thank you. So Arizona has — and I’m going to give you an example of a way that we’ve started looking at this to ensure that we are ready.

So first of all, Arizona is not supply-constrained as a number of other states who have recently come online are supply-constrained. But in Arizona, because you have the vertically integrated licenses, what that allows you to do with each and every license is have a retail store and an offsite cultivation and manufacturing facility as well.

So for us, obviously, with 15 and now 18 licenses, we’re not going to have 18 different cultivation facilities. That has allowed us as an organization to effectively lease the rights under some of those licenses to other people who are interested in operating, cultivation and manufacturing facilities.

In anticipation of RAC, the RAC rollout next year, many months ago, we started changing the way that we do those agreements. And what we started doing is we started ensuring that when those facilities are productive, that we have a right — the first right to take product that comes out of those facilities.

So for a number of months, we have anticipated — as a lot of people know, our internal polling for the campaign has been consistent throughout this process. So at Harvest, we have been betting that the vote was going to turn out the way that it did. And as a result, we have adjusted our business practices to capitalize on the opportunity and utilizing things like the unique licensing structure that we have in Arizona.

Graeme Kreindler

Okay. Got it. Understood. I appreciate that insight there. Then a lot of talk about revenue potential here. I’d be curious to get your thoughts specifically on Arizona Retail, on whether you think there’s going to be any major differences on the 4-wall economics or the overall profitability at retail. Is that expected to stay the same, improve, potentially degrade a bit as you head into a RAC market?

Steven White

Well, if you think about the short term, it would be — when you compare it to other states, what you’ve seen in other states is the — there’s a package or a passage of a law that allows for recreational sales. That’s followed by significant infrastructure development.

So if you think about how Arizona is rolling out, that’s not the way it’s going to be here. It is really true that in Arizona, you’re taking existing stores and you’re pushing additional customers into those stores. So initially, you’re going to see an increase, a significant increase in operating leverage in the state. It was very intentional in how we devise that initiative, so that we take the existing infrastructure that’s already been developed. It allows us to get the program online faster and it allows us to not have the delays that we’ve seen in other states in getting supply out to everybody.

Graeme Kreindler

Okay. Got it. And then just a last question here, I’ll jump back in the queue, switching gears. With respect to the guidance here and the increase in the quarter, you mentioned 85% of the revenue this quarter comes from your core markets. In terms of, I guess, the outlook for the remainder of the year, and what’s really driving that growth, is that split, expected to meaningfully change at all heading into the fourth quarter here? And maybe you could give a pecking order in terms of those core markets, in terms of growth rates, on how that’s changing. I’d imagine that something like Pennsylvania, where you’re opening more stores, is probably exhibiting a pretty fast growth at this point in time.

Deborah Keeley

Sure. So we expect to have full year revenue over $225 million. How much of that over will depend on whether or not we complete divestitures before the end of the year. The 85% revenue comes from our core states. We expect that percentage to kind of stay in line and continue. And as far as the mix between retail and wholesale and licensing, we expect that mix to kind of stay about the same also.


Our next question comes from Andrew Partheniou with Stifel.

Andrew Partheniou

Congrats on a great quarter, guys. I wanted to talk a little bit about Arizona and the snowbird effect that may not have occurred this quarter. Could you talk a little bit about how that may have either benefited or impacted your performance here? And how is that different from a typical year where COVID is not necessarily in the picture?

Steven White

Yes. I mean, we will — it’s a great question. The answer to the question probably does rely in fourth quarter results, though because a lot of what we — a lot of the snowbirds, we see them migrate, if you will, to the Arizona’s warmer temperatures in the fourth quarter.

We don’t know that a lot of the people who participate in the recreational — or excuse me, in the medical program are snowbirds because you have to have a permanent residence in the state of Arizona to have an Arizona medical card.

What I think that, that question really hits upon is in future years, the question of how good or how effective are we going to be in educating visitors on the availability of recreational consumption in the state of Arizona. And when you look at other states that are heavily dependent upon tourism, they’ve struggled in that area, frankly.

And so we have some different plans, some different mechanisms to try to activate some of those visitors when they do come to Arizona in the winter months.

Andrew Partheniou

And I think typically, in the summer months in Arizona, you see residents of Arizona, not on a COVID year, obviously, typically flee the hot weather. How has that impacted Q3, if at all?

Steven White

So we don’t know if it has had a material impact in Q3. What we have said in years past is that there is a seasonal slowdown in the summer months in Arizona. But we haven’t mentioned or haven’t talked about that or disclosed any information related to that this particular quarter. What you can do is there is some information that is published by the state on total consumption numbers. And if you extrapolate from some of those numbers, your hypothesis about COVID having a dampening effect, those numbers will probably support your hypothesis that COVID has a dampening effect on people migrating to and from Arizona during the hot and cold months.

Andrew Partheniou

And just to follow-on, on your comments of tourism and the coming RAC market. I think you guys have a partnership with the Cookies brand, which we haven’t really seen a lot of successful brands, but I would argue that Cookies is probably one of the more successful ones. How do you guys plan to leverage that? And in particular, do you think it could provide you with some kind of competitive advantage in the state?

Steven White

Yes. Obviously, we wouldn’t have that relationship if we didn’t think that it provided us with a competitive advantage. And I would agree with you that they’ve done a fantastic job of carrying a name across state lines, maybe one of the best to have actually successfully done that.

To date, we’ve been real pleased with the success of our program with them. And we do plan on continuing to leverage that partnership to drive consumers to our stores in both the medical and, ultimately, in the recreational market as well.

Andrew Partheniou

Congrats again on the great quarter.


Our next question comes from Pablo Zuanic with Cantor Fitzgerald.

Pablo Zuanic

Just two general questions, and congratulations on the quarter. Can you talk about whether your current retail stores are outperforming, underperforming or being in line with the market? I mean I worked out that they are doing about $6 million to $7 million in annualized terms. And the average, I think, for the state is about 9 to 10. So correct me if I’m wrong, but just remind us, obviously, you have 15 stores, how are they performing versus peers?

And related to that, I understand the logic of the way the plan is being developed, and you’re saying, of the 130 stores, people will not open new stores, they will just offer rec services in their next stores. But what if I’m — could lift for someone else, and I decide that this gives me the opportunity to double my number of stores. The way I read the regulation, it allows you to do that, right? So I’m just wondering, in your case, you are opting for offering rec in your next stores because of just a cash flow issue? Or eventually you would open — you would double your store count if peers are doing that.

Steven White

Thank you, sir. And I’ll take the questions in reverse. First, the initiative as drafted requires colocation of stores. So it’s not a choice that we’re making to not double the number of stores, it is a requirement. And so it is going to be true in Arizona that existing medical stores will service both medical and recreational patients through the exact same stores, and that will be true of any additional licenses issued pursuant to the recreational program as well.

With respect to market share in Arizona, I think — I would suggest based on the numbers that we have seen produced by the state of Arizona, that your numbers on the average stores are quite high. And what Arizona does is they don’t actually publish the actual revenue generated per store. The information provided is the total amount of pounds purchased at cash registers.

The challenge with extrapolating from that, what the total market size in dollars is, is twofold. One, it presumes a certain pricing element, which I don’t think is fair to presume because they’re — the people do charge vastly different prices in the state of Arizona.

And secondly, the way that people record the weight in the system, the Arizona system, differs. And so in some instances, those weights are under recorded. In some instances, those weights are over recorded.

What I would say about market share is because we don’t have enough information, we haven’t publicly commented on what our market share looks like in the state of Arizona. We do anticipate once recreational sales start, that we will have an avenue to be able to see or have some visibility into the revenue derived by the program because of the excise tax and the — and how the revenue is going to be dedicated to a number of programs.

When that information is available to us, we will happily talk about it in quarterly calls. We don’t have any shyness. I would say that we are confident that when we produce that information, it will show well for us.

Pablo Zuanic

Okay. And just on that point, I mean BDS analytics, I think they calculated June $91 million and July $94 million but I’ll move on. In terms of the colocation, that’s a rule. It’s not a choice, as you said. Do you foresee that changing over the next 12, 24 months? Or it’s unclear? Or it stays permanent that way?

Steven White

It’s a good question, Pablo. And the reason why I’m confident in telling you that it’s not going to change is because the only way that it could change is if somebody ran another initiative and the citizens voted on it.

When we looked at how you draft the initiative in Arizona, and we laid that against the Voter Protection Act that I discussed earlier, there were certain things that we wanted to make sure would be implemented as we conceived of them. The colocation of retail dispensaries is one such thing. So that will be — that will remain true in Arizona unless and until there is some other ballot initiative that changes it, which we don’t expect that to happen in the very near future at all.

Pablo Zuanic

And just a quick follow-up. I understand the logic of not investing in cultivation in Arizona. You talked about return on capital. So can you just roughly give an idea of wholesale prices comparing Arizona with either Pennsylvania, Maryland or Florida? Just for context.

Steven White

So with comparing it to Florida, there is no wholesale market. So that one is — yet. So if you compare it to Pennsylvania, what I would say is this. I mean, we haven’t gotten into specific retail — or retail or wholesale numbers or pricing in information we have disclosed. But what I can tell you, which can help you get there is that Florida is supply-constrained, and that obviously has an impact on pricing. Arizona is not so supply-constrained, and so that has an impact on pricing as well.

Pablo Zuanic

Okay. And one last question. This is a bit more philosophical. But in this industry, some people talk about being more about on the cultivation side, wholesale, others more on the retail side. The way I hear you’re least I guess for Arizona it’s retail, in other states will be more opportunistic, right? But when you think about the case of Pennsylvania and the risk that rec will be handled by the liquor stores, how does that color your strategy, right?

I realize it’s not a one size fits all, right? Arizona sounds mostly retail. Can I extrapolate that for other states, or it will deepen? Just trying to understand that because there is a risk to retail in terms of 2, 3 years out, how the industry are — how the regulators at the federal level, decide to handle the retail of cannabis?

Steven White

Yes, it’s a great question. And the way that we look at — we do look at it, as you mentioned, kind of state by state, it’s opportunistic is a good word. The way that we look at or what is instructive for us is about how a state is going to roll out a particular program as we often look at how they handle the distribution of alcohol.

And so in the state of Pennsylvania, which you referenced, it is a much more wholesale dependent market in cannabis than Arizona is, for example, because of the numbers of licenses and the number of participants in each part of the value chain. But we do think that there are a number of states. When we don’t have the certainty that Arizona provides, given the constitutional amendment, we look at a number of things. The primary thing we look at when we determine how we think a state is going to regulate is how they regulate alcohol sales.


Our next question comes from Matt Bottomley with Canaccord Genuity.

Matt Bottomley

Just going back to Arizona, I know you guided on sort of the production, market opportunity here. So it looks like based on some of the numbers that you’re talking about on potential upside here, might be a 2.5x increase from the current annualized run rate in the state.

So can you give any color, maybe at a higher level on your production, like what percentage above your existing Arizona sales is your existing capacity? And maybe just keeping new counts within because I know it depends on if you’re selling flower or various different products. And then also what your overall market penetration is by store count into the 130 or 40-odd stores that are around today?

Steven White

So a lot of questions in there, Matt, and I’ll try to hit them. And if I miss some, please follow up. So in terms of market penetration for wholesale, what we have told people previously is that in Arizona, we are a net buyer on the wholesale market. So the wholesale component is not a significant component of what we do in the state of Arizona. That has been different in the past, and we have had market penetration to the tune of about 90% of open stores when we were wholesaling and distributing products. That was quite a number of years back, though.

The way that we look at capacity is there are a couple of ways that you could achieve capacity. One way would be to invest the dollars necessary to increase your existing capacity in the state of Arizona by adding to our indoor, our greenhouse or outdoor production. The other way to do it is through, what I mentioned before, and that is through licensing arrangements.

And so given the fact that what we do and we’re trying to decide is — what we know is we want to make sure that we have products on our shelves and that we want to account for increased demand as a result of new customers coming to our stores. There are a couple of ways we get there. And I would suggest that it’s probably going to be some mix of those ways to ensure that we maintain enough products for everybody who wants to come buy them.

Matt Bottomley

Appreciate that. And then any commentary on keeping everything constant if the market size were to double or even triple, what your current capacity requirements would be given where they are today and just what your sales are today?

Steven White

Yes. At the retail level, they would if the market doubled or tripled. Obviously, our retail capacity would need to double or triple. In terms of what we would need to do as an organization, that would depend entirely upon our relationships in the marketplace. And I can tell you, one of the things that we have said is our plan — our plan has always been in Arizona that we are retail-focused because that is where the value lies.

Matt Bottomley

Perfect. And then maybe if we can just switch over to Pennsylvania, you haven’t said as much on there. So do you have any commentary on I guess, firstly, if New Jersey is going legal puts extra pressure on that market to potentially do something as the legislature. Obviously, New York has been talking about it. And I know it’s a bit of a crystal ball question, but there has been positive commentary coming out from various payers and governors of that state, and there’s been a bit of back and forth with those in the legislature itself.

And then I guess your commentary in Pennsylvania on how it’s growing, the numbers that come out from the state itself aren’t as robust as others, but it seems like the take and uptake is still very strong and grows. So any commentary upon the market growth or patient uptake in that market as well?

Steven White

Yes. What we have said about Pennsylvania is, we recently opened a couple of additional stores. And while it’s early, the returns have been strong. That’s about as much as we’ve given in terms of the demand that we’re seeing in the state of Pennsylvania. And I’m sorry, Matt, remind me of your previous question.

Matt Bottomley

Yes. Just also if New Jersey is going legal and some of [indiscernible]?

Steven White

Oh, yes, yes. Yes. If you look at the map, and we provide it in the slide deck, I think it’s not a coincidence that a lot of the recreational states touch each other. And so the New Jersey, ultimately — New Jersey made a decision. They haven’t — we don’t know exactly what the timing looks like on initial sales. But undoubtedly, when the state of New Jersey starts realizing revenue from something that adjacent states are not realizing revenue from, it’s going to put incredible pressure on those adjacent states to make changes.

You have heard a number of those adjacent states talking about this already, the ones that you mentioned — you’ve heard it from — about Pennsylvania, and you’ve been hearing it about Pennsylvania. You’ve also heard it about New York. It wouldn’t surprise me — I guess, Connecticut as well. It wouldn’t surprise me to see a run of legislative actions in order to bring rec sales to those states.

Matt Bottomley

Perfect. And just one final one for me. And Deborah, maybe you could chime in as well on this, or Steve as well. Instead of another crystal ball question, and I know you love those. But just with Arizona going legal, where you’re positioned in Arizona, the Dems going in the White House and then we’ll see what happens in the Senate. I mean what do you think Harvest cost of capital potentially could be at least directionally? I’d imagine there’s some improvement there. But do you think there’ll be meaningful increase in potential investors coming onto the space with these changes? And does that make sense, given that you’re currently well positioned to service your current debt. But obviously, an eventual refinancing or pushing out or something in the next 2 years might be beneficial. Anything tangible on that front that you could speak about, given some of the changes at the federal level?

Steven White

Yes. I mean — and I’ll let Deborah talk after I answer. But what we have seen generally is the cost of capital is going down. That directionally is what is going to happen, and that will continue to happen because the cost of capital in this industry is unlike anything else. So you have seen and will continue to see other financing companies of some kind, enter the space because the returns for them are impossible to ignore.

Deborah Keeley

And I would add to that, that we do have a plan to recapitalize our balance sheet. And I do think that over the coming months that there’s going to be more opportunities. So I do think that the Arizona going rec is absolutely going to help with our cost of capital and our ability to recapitalize our balance sheet.


Our next question comes from Russell Stanley with Beacon Securities.

Russell Stanley

I guess first in Arizona, I think the plan calls for a max of 166, I guess, 36 of those are still to come. How long in practice do you expect it to be before those new entrants are up and running, understanding that, that’s a relatively small number of new entrants. But how long in practice do you think that the incumbents will have a head start?

Steven White

That’s a great question, and one that is unfortunately a little bit difficult to answer. With respect to the larger chunk of those licenses, the social equity licenses, there’s a lot of research and studying that needs to be done before that program actually launches. And so the initiative requires 2 branches of the Arizona government to get together and start putting together that program. So that’s going to take a little time.

The reason why that — it was structured that way is because it’s not an easy thing to get right. And we’ve seen a number of states try to get it right. And then we’ve seen some positives and some negatives from the efforts in other states. And so we wanted to make sure that they were the right people and the right number of people at the table to make those determinations. But that might take a little bit of time to get it right.

With respect to the few additional, limited-to-county areas. The way that the initiative is structured is some of those could come online with the early application period. And when I say come online, I mean the license could be issued, simultaneous with the issuance of our recreational licenses. And so you might see 10 get licensed about the same time as our existing stores.

The challenge that those license getters will have is they won’t have existing stores from which to serve people. So they’ll have to go through their zoning process potentially in counties that are not friendly to cannabis at all, let alone recreational sales. Once they get those stores up and operating, they’ll be able to sell recreationally.

It’s important to note that if — when those are issued, those will not be issued, they won’t be dual licenses, so they won’t be able to sell medical. It will only be rec sales for those.

Russell Stanley

That’s great color. And maybe if I could just move on to Pennsylvania, I guess. Where are you at with — you talked in the past I guess about working towards quadruple and with the Reading facilities capacity. How would you — I guess, what your progress so far? How far along in that expansion are you at this point?

Steven White

So the increase in capacity in Pennsylvania is an ongoing project. It’s one that we expect to have some significant progress on in next year. And so we hope to be in a position to talk about it during our next conference call. But as you know, we were — when we acquired that facility, it was selling wholesale product, and we were a buyer of that wholesale product. But the progress of adding capacity to that facility is ongoing.


Ladies and gentlemen, we have reached the end of the allotted time for questions. This concludes today’s conference call. You may now disconnect.

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