Earnings Transcript for APPH - Q3 Fiscal Year 2021

Operator: Good afternoon, and welcome to the AppHarvest Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to the call host Kaveh Bakhtiari. Please go ahead.

Kaveh Bakhtiari: Thank you for joining us on the AppHarvest third quarter 2021 earnings call. I'm Kaveh Bakhtiari, VP Finance and Investor Relations for AppHarvest. Joining me in Kentucky today are several members of the senior management team including Jonathan Webb, Founder and CEO; David Lee, Board Member and President; and Loren Eggleton, Chief Financial Officer. A copy of our earnings release is available on our investor website at investors.appharvest.com. On today's call, we will begin with prepared remarks from Jonathan and the rest of the team. Then we'll open the call to questions. Before we start, I'd like to remind you that comments today regarding the company's future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the securities laws. These statements are made based on management's current knowledge and assumptions about future events, and they involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations please see our most recent SEC filings. And with that, I'd like to turn the call over to Jonathan.

Jonathan Webb: Thanks, Kaveh. I'm impressed and proud of the progress our teams made in the third quarter. First, we delivered on our top priority of efficiently wrapping up the first growing season and completing the summer refresh and replanting on schedule in September. We accomplished this while achieving net sales results that were a little better than we expected coming into the quarter. In doing so we remained on track with the 2021 annual outlook that we shared in August. Next along with key leadership changes, we designed and implemented an effective new training program. The training resulted in a quadrupling of the number of crop care specialists earning a productivity bonus. As a result through the first part of the fourth quarter the mix of number one tomatoes we produce was increased and is currently above our internal projections. Improved quality and our production provides the dual benefit of increasing the price per pound we receive for our tomatoes and lowering our distribution costs. And finally, we continue to make progress on our farm network in Kentucky. Along with consistently improving our operating results, development of our network of farms remains a top priority and key focus. We expect additional high-tech indoor farms to be operating at scale by the end of next year. These farms will diversify our crops with leafy greens and berries which we expect to lift our realized price per pound while reducing volatility. We expect this to remain a bright spot for our development team in the current environment. Our teams across the company are energized by our mission, which remains important as ever given climate change and continued strong interest in sustainable solutions like our controlled environment agriculture approach. We're entering into a second growing season with lessons learned and more experience under our belt. We're excited by the opportunity to raise the bar as we harvest this new season's crop. Our operation is performing at a higher level. The development team and construction teams continue to work on expanding our farm network. The finance team has done a great job of positioning us to raise the additional capital necessary to fund our expansion of farms. As one of only a handful of traded public benefit corporations that are also B Corp Certified, we're moving to a sustainable future with ESG principles as our foundation. To sum-up, we're making progress towards our long-term goal of building AppHarvest into one of the most trusted sustainable food companies in the world and into a leading applied technology company serving the global CEA industry. With increased scale and diversity across by the end of next year, we expect the progress we're making to deliver long-term value to our shareholders, employees and communities. Our President, David Lee now will provide more detail on the quarter. David?

David Lee: Thanks, Jonathan. I'm also pleased with our progress in the quarter. We focused on the fundamentals of our business and delivered our top priorities improving operational performance at Morehead and new farm development. Before I get into more detail on our strategic initiatives, I want to do a deep dive on the quarter beginning with operations. In the third quarter, we wrapped up the harvest from our first growing season a little early to better prepare for the current season and sold nearly 1.5 million pounds of tomatoes for over $0.5 million. Importantly, Q3 results do not reflect the new plants and operating changes from the summer refresh. Q3 results reflect remnants, Q2 plants planted pre-summer refresh. This resulted in $0.37 per pound a figure driven by factors similar to last quarter namely an unfavorable ratio of USDA number one versus number two tomatoes, historically low market prices for tomatoes and higher distribution expense. However, we expect the leadership changes we have already implemented that refocus the business on quality and the investments we made in improving training to pay off in the second growing season. In fact, although it's early in the harvest in Q4, we're encouraged by the progress we're seeing, specifically

Loren Eggleton: Thanks, David. I'll start by reviewing our third quarter results, give an update on our development time line and financing and then move to the 2021 outlook. We achieved third quarter net sales of $543,000 as compared to no sales in the third quarter of 2020 before our Morehead was operational. In terms of yield, we generated approximately 1.5 million pounds of tomatoes for sale at similar economics to the second quarter, as the first growing season stretched into the beginning of the third quarter. However, our third quarter net sales still came in above our initial projection as we concluded the first growing season. As Jonathan and David mentioned, we've made significant operational progress based on lessons learned from our first growing season and are optimistic about our second growing season. We recorded a net loss of $17.3 million and adjusted EBITDA loss was $16.5 million in the third quarter in line with expectations. Third quarter results were driven by continued labor and productivity investments associated with the training and development of the new workforce at the Morehead Farm and costs associated with the summer refresh and planting of the new crop to prepare for the second season. As we have discussed previously, quality is the most important determinant of our tomato pricing. We are encouraged by the initial quality through the first several weeks of our second growing season in Q4, and we are seeing tomato prices rebound and the seasonal lows typically experienced in Q3 based on the 10-year historical data from the USDA. Let me turn next to our progress on farm development and financing. Work continues on three previously announced CEA facilities now under construction. We remain on track with our external guidance from last quarter to deliver nine high-tech indoor farms by the end of 2025. Our 15-acre Berea Kentucky leafy green facility and our 60-acre Richmond Kentucky tomato facility are both over 50% complete and both are scheduled to begin operations by the end of 2022. In June, we announced that we broke ground on a 30-acre berry facility in Somerset Kentucky. The Somerset facility is approximately 30% complete with operations expected to begin by the end of 2022. In June, we also announced that we've begun initial site prep on a 10-acre leafy green facility located adjacent to our flagship Morehead Farm. We made a strategic decision to pause construction temporarily on this facility for two reasons

Kaveh Bakhtiari: Thank you, Loren. With that, operator, we'll now begin to take questions.

Ben Theurer: Hey, good afternoon and thank you very much for taking the questions, Jonathan and David, Loren. Congrats on the results. That was obviously a little better than expected and even a little above your expectations. So two questions, if I may to start off. So first, you basically said in the commentary and the prepared remarks that you're off to a better start when it comes to number one tomatoes in the current quarter and that your outlook also is that pricing is going to recover. So the question really is, what have you made different at the beginning of this harvesting? How much have you learned or taken away maybe from how you now more partner with the funds at Mastronardi, just to give you an update on, what are the changes you've been implementing to actually achieve that better level than what your initial outlook was? And then the second question, just to understand it right, Loren on the change and -- changing the decision to stop temporary -- to pause temporarily, the Market North addition for leafy greens. Do I understand it right that as you said, it's really about let's get one facility for leafy greens done first to see what we can improve in the second instead of building two at the same time? Those would be my two first initial questions. Thank you.

Jonathan Webb: Yes Ben, it's Jonathan. I'll start. So, yes, our number ones are up almost 20 percentage points in Q4 versus Q2 so far. And that's really been due to a new training program that's resulted in four times more crop care specialists earning productivity bonuses. So, the work we've been putting in to have the right process and procedures in place under Julie Nelson's leadership are really starting to take effect. And I'll let David talk to the pricing point that you had mentioned a moment ago.

David Lee: Yes. One of the things Ben we're doing a better job of is partnering better with Mastronardi because, they are so good at understanding the market. A lot of the changes that we've seen on quality new training comes from a lot of the best practices they've seen amongst all the best operating CEA facilities that they work with. With regard to pricing, just to underscore this, it's very important to note that the Q3 results do not reflect all the improved operations that we've worked with in order to ensure that post the refresh, we have the better performance that Jonathan just mentioned. Q3 price is really a remnant of some of the historical challenges we reported in Q2. I wanted to also point to the commentary, we did study very hard 10 years on a monthly and quarterly basis for total USDA tomato pricing, because aside from our view, I think it's important for us to provide the empirical evidence that, when you look at the last 10 years of overall USDA tomato pricing from a trough that you see in say one quarter, there appears to be roughly a two-quarter lag between that trough reverts to the midpoint across the 10-year average. And that along with early feedback from our market partners make us encouraged that we will see better pricing broadly in the market. And the more number ones that we can make aside from where the market is, the better gross pricing we receive and the better net pricing we receive because we incur often less of the repacking distribution fees that come with non-number one tomatoes. Let me pause there and turn to Loren for your question with regard to our development.

Loren Eggleton: Yes. Ben, so I think, it's important to remember that we're still on track to achieve the nine facilities by 2025. We are pausing more head north for the two reasons mentioned on the call. One to provide us financial flexibility; the other to incorporate design and other changes we know we'll likely want to make after offering our first leafy green facility at Berea. After constructing the Morehead facility, we recognized that there were certain things that we wanted to change for our next tomato facility changes that we did implement into the Richmond facility such a different pack house and layout different type of air handling system. Those sorts of things that, we want to be open in place. Regarding the financial flexibility, the market currently seems to show a preference for funding CEA assets on a project-by-project basis which we're comfortable with and are having a lot of success with the shipments approach. We still expect to complete Morehead North. Our current estimate is just that it shifts into 2023 instead of 2022.

Ben Theurer: Okay. Perfect.

David Lee: Hey, Ben. One last point that, I want to mention, Berea is not a small facility, having a 15-acre leafy facility could arguably one of be the largest of its kind in North America. And so this is in no way of pullback from diversifying our crop into I think a very interesting leafy business that is on track by end of 2022 at Berea.

Ben Theurer: I was not saying small with the 15-acre, but 15 acres is smaller compared to 60 acres. Anyway, that's a different one. And then one last follow-up, David you can keep this brief. Just around the restructure you've announced roughly three months ago between AppalachiaCo, GrowCo. You haven't talked much about details in the prepared remarks. I was just wondering, if you have any update on the three different ones and particularly on the proposed JV on the GrowCo together with Mastronardi. Anything you can share?

David Lee: Yes. First, I just want to make sure, I remind all of ourselves that, the structure we announced was to allow our management to be even more focused on our core Appalachia business, and to leverage sources of funding that's not from our own balance sheet to go after the considerable growth outside of Appalachia. One of the things, I don't know that, I communicated well on the last call, was that the strategic structure creates more focus and less execution risk on our core business. Having said that, we've made great progress both with FarmCo in partnership with Mastronardi. We actually have received initial terms from one of our existing lenders for potential loan amounts for the contributed assets that we mentioned in our last call. And we've had formal meetings with investors that are quite encouraging. We're not ready on this Q call to announce those results, but I'm very encouraged by the progress on FarmCo. We've also made great progress on TepCo. We didn't want to mislead our investors. This is not our primary area of focus. Our core business is our primary area of focus but TepCo helps us in our core business. In fact we've actually deployed two harvesting robots, or we will be slated to deploy them soon in Morehead, as we discussed in the last quarter. And we have already deployed significant improvements in some of the pack house design and operating systems that we find in the refresh from our tech team. But we'll provide much more color commentary on those two strategic initiatives in the call that comes next quarter.

Ben Theurer: Perfect. Well, thank you very much, Jonathan, David and Loren.

Operator: Your next question comes from the line of Brian Holland of Cowen and Company. Your line is open.

Brian Holland: Thanks, and good afternoon, everyone. So just a couple of points of clarification, it sounds like and forgive me, if you were clear on this – I missed it. But revenue per pound early on in Q4 has moved off kind of that $0.35 per pound range. And again, I appreciate it's just a couple of weeks in here, but we are seeing sequential improvement in that metric specifically?

David Lee: Yeah. Let me clarify that. First, I want to point out that, here we are two weeks into Q4. So I don't want to overstate the initial progress that we're excited about though we are excited. The number one driver of improved net pricing for AppHarvest is within our control, which is how many number one USDA quality tomatoes we produce, as well as the varieties we produce. And we noted that, for example, for the first time we've introduced a specialty crop, which has historically priced, when you look at history higher than the non-specialty crops is the Campari crop. So we're encouraged by the things we can control, which is the quality as well as the specialty items that we're producing. We're also encouraged in the first two weeks by the predictors of yield. The reason why we talked about training and we talked about productivity bonuses is that's how we harvest better. Now, I want to comment on what we can control, which is the 10-year analysis, I mentioned on a large USDA tomato prices here in the US. We've really studied how trough pricing reverts to mean pricing and seeing 10 years of data across the sector and seeing how quickly these consumables. Remember these protest items are not like a lot of consumer packaged goods items. They're consumed and produced frequently. And seeing that two-quarter lag on average from the trough reverting to the mean, gives us confidence. And then lastly, while it's only a few weeks into the quarter, we are very much in touch with the market. And early indications from market signals suggest that this quarter should be a better quarter with regard to market pricing broadly.

Brian Holland: Yes. I appreciate the color there, David. And maybe to that end, you brought in Julie Nelson this past quarter. I think you called out in the press release here sort of data-driven approach to real-time performance management. Maybe this leads into a bigger question, but just obviously you talked about the number of things that are in your control. You instituted several measures brought in a lot of leadership here. Can you talk about an example or two specifically of where you're seeing tangible evidence? And maybe if it's on the labor and productivity side and if it is just like to understand specifically, what those folks are doing that wasn't being done before such that this is not just – this is a sustainable and – sustainable level of improvement that can build the momentum as you add more folks and more facilities?

David Lee: Yes. I call upon a number of items that Jonathan already mentioned but let me call upon three key drivers that encourage us. First, with regard to management changes, recall in the last quarterly release, we announced the hiring of Julie, but she hasn't started. We announced her hiring in early August. She started shortly thereafter in mid-August. So she has been hands on running Morehead, eliminating a layer of leadership and improving the leadership there for a couple of months. And I want to underscore that, hiring folks who have a history in packaged food and in particular her PepsiCo food experience and her McKinsey experience, we thought would suit us very well and we're finding that indeed that approach to rigor and accountability has. The second thing aside from management, is I point to data, we all talked about controlled environment ag versus open field as the benefit of measuring. A lot of the key factors in predicting improved yield. We've significantly increased the use of our data system so that we have now high-quality inputs going into the data programs that really fuel the daily and weekly dashboards that we can see on the drivers of performance. We're publishing to ourselves these diagnostics that give us a better chance of improving every week. And then lastly in terms of how it shows up Jonathan mentioned that this new training shows up in four times more of our workers in the farm earning productivity bonuses. This is about peace rate. This is about people going above and beyond the minimum and actually achieving more productivity that we incent. And the more we can see sustained labor productivity that turns primarily into yield. So again, early two weeks into this Q4 period but we're very encouraged by the performance to date.

Brian Holland: Got it. And then last one, which again as a point of clarification here. When you talked about pausing Morehead North, you talked about implementing some learnings. But you also talked about – and maybe I just jotted this down, right, so it would be great if you could just kind of clarify. Are you exploring additional means of finding financing or capital i.e. you're not actually able to find it or you're just deciding how best to deploy it? And just – you're just – you're stepping back to give yourself more flexibility?

David Lee: I will tell you, I consistently in the last six to nine months being with AppHarvest, been surprised by the more options we have in off-balance sheet financing. Just look at what we've announced in Q1, Q2, what we just announced in this Q3 release. The 60% LTV program at the low end of 4% for Morehead that we announced previously, the new facilities from Equilibrium. I think the capital markets are waking up that CEA will be a global inevitability and we are seeing more interest from more parties. And so before we commit to one traditional source of financing, we want to take a beat. And I want to be clear, we are on track with our development. Remember, we guided to nine farms but we're internally still targeting 12 by 2025. That still remains true. But I want to make sure that we match our sources and uses to the best return on invested capital. I want to turn to Jonathan, because he's very close to the pace of our development independent of the capital that funds it.

Jonathan Webb: Yes. Just wanted to touch on – we are building some of the largest infrastructure in the world right now in the middle of what is supply chain pressure globally and we're able to navigate that. And for us we wanted to do the prudent thing, which we think is launch three farms into next year versus four allow our construction and development team to continue to perform and outperform on a weekly basis. And so just narrowing the focus of our development and construction team, while allowing David and Loren to continue to explore all of the various financing options that are available. So we just thought it was the most prudent thing for us to do, as we close out this year going into next year.

Brian Holland : I appreciate the color. I’ll leave it there. Best of luck.

Jonathan Webb: Thanks.

Operator: Your next question comes from the line of Kristen Owen of Oppenheimer. Your line is open.

Kristen Owen: Hi everyone. Thank you for taking the question. If I could follow-up just on the last point that you made Jonathan about the supply chain and the inflationary environment. If you could just remind us how you're managing the building commodity costs and the shipment of your prefab facilities. Just talk us through how you're managing those cost items. Thank you.

Jonathan Webb: Well, we have no delays expected with completing and operating four farms by the end of 2022. We've had no material impact on pricing. No material issue of getting products too to our farms, but that is because of our team. Obviously, we are facing the same environment everyone else is with global supply chain issues. Our team is just problem solving on a day-to-day basis. And I do believe that that is one of the firm bright spots of this company is being able to develop and construct on time on budget.

David Lee: I just wanted to add to that Kristen in that in addition to Julie, I will note that we hired a great Vice President of Supply Chain that has a professional background, so good management health, but also frankly, the scale of our development helps. We have the ability to attract some of the leading suppliers, because they know what we're going to be building targeting 12 guiding to nine by 2025, and these are large facilities. So I think that gives us an advantage beyond our execution in kind of preventing some of the inflationary and supply chain issues you see with other companies.

Kristen Owen: I appreciate that color. And again, you sort of teed up my next question here, which is you've gone through this rapid expansion over the last year. A lot of things have changed within the organization. But the mantra and the soul of the company has really stayed the same. I wanted to ask you a question that may seem silly at this early stage of the business, but how are you finding employee engagement at this stage and employee retention, because that's obviously another source of friction in this market?

Jonathan Webb: Yes. We -- I have stopped tracking it, but at one point this year we had nearly 8,000 people apply to work at this company. We just -- we've been hosting various political leaders across the spectrum from our governor to Senator McConnell earlier this week both left and right, who continue to ask us how are we getting employees, how are we retaining employees in this environment. And I think it has to do with our mission. We've set out to go on a bold mission to pursue being one of the largest food and agriculture companies not only in this region, but in the US and world. And we have people that want to help us hit those targets daily and weekly. So we've had no real material issue on building a team other than scaling from what was 20 employees to 400 employees and then nearly on track to be at roughly 2,000 employees a year from now. So maintaining that culture and being mission-first has been something we're very proud of and continue to result in large benefits throughout the organization.

Kristen Owen: That's great to hear. I’ll leave it there. Thank you so much.

Operator: And I'm showing no further questions at this time. This will conclude our conference for today. Thank you for your participation. You may now disconnect.