Village Farms International - Earnings Call - Q2 2018

Transcript

Speaker 0

Good morning, and gentlemen. Welcome to Village Farms International Second Quarter twenty eighteen Financial Results Conference Call. Yesterday, Village Farms issued news release reporting its financial results for the second quarter ended June 3038. That news release, along with the company's financial statements, are available on SEDAR and on the company's website at villagefarms.com under the Investors heading. Please note that today's call is being broadcast live over the Internet and will be archived for replay both by telephone and via the Internet beginning approximately one hour following completion of the call.

Details of how to access the replays are available in yesterday's news release. Before we begin, let me remind you that forward looking statements may be made today during or after the formal part of this conference call. Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward looking statements. A summary of these underlying assumptions, risks and uncertainties is contained in our various securities filings, including Village Farms current annual information form for the year ended December 3137 and MD and A for the quarter ended June 3038.

These forward looking statements are made as of today's date and except as required by applicable securities law, we undertake no obligation to publicly update or revise any such statements. I would now like to turn the call over to Michael DeGillio, Chief Executive Officer of Village Farms International. Please go ahead, Mr. DeGillio.

Speaker 1

Thank you, Stephanie. Thanks everyone for joining us both by telephone and Internet. With me today for the call is Village Farms' Chief Executive Officer, Stephen Raffini. In terms of the agenda for today's call, I'll begin with an update on the continuing process of Pure Sunfarms, our joint venture for large scale, high quality, low cost cannabis production in Canada. Steve will then do a brief review of our second quarter financial results, and I'll return for some concluding comments before Steve and I take your questions.

So beginning with Pure Sunfarms, it's been a very busy and productive summer so far as our cannabis joint venture achieved several important milestones on or ahead of our planned schedule. As I discussed in our last call in May, Pure Sunfarms received its first amendment to the cultivation license for the 1,100,000 square foot Delta 3 facility in Delta, British Columbia, which enabled the Pure Sunfarms team to begin commercial scale production on the first 130,000 square feet. Just a month and a half later, Pure Sunfarms received its second amendment enabling to expand production at Delta 3 at the Delta 3 facility to 225,000 square feet. By the July, all of the flower rooms in a license area were fully planted out in production. On July 27, Pure Sunfarms received its sales license from Health Canada for the Delta 3 facility.

We are incredibly proud of the speed at which Pure Sunfarms was able to achieve this, especially given the magnitude of the operation with ongoing construction and management employee ramp up, just one hundred and forty four days from receipt of the cultivation license, to our understanding about twice as fast as the average. It's a testament to the value of the decades of operational experience that Village Farms brings to the table combined with our unwavering approach to always do things the right way and the right way the first time. Pure Sunfarms has just completed its first sales of cannabis. So in well under a year since submitting its application for a cultivation license, Pure Sunfarms has completed conversion of 500,000 square feet or half of the facility with the first 250,000 square feet of Delta three growing and harvesting at commercial scale and now generating its first revenues and as we wait approval for the next expansion. As you will recall that Pure Sunfarms had an initial distribution agreement in place and is in discussions with other licensed producers for supply.

There is no shortage of interest and we are also discussing opportunities with various provincial government distributors. Looking out a little further, we know that reliable suppliers of high quality, consistent large scale will be valued in the marketplace and we believe we are well positioned for whatever the retail market holds going forward. There is consistent change and we're standing by to see where it ends up. But for Pure Sunfarms, it will become a vertically integrated producer, as we have said, with its own products and its own brands and we are confident that Pure Sunfarms goal to be the lowest cost producer in Canada will provide it with an increasingly meaningful competitive advantage, a very durable, sustainable company in the long term as the cannabis market finds its niche and matures. I'm also pleased to report that we've continued to we're in the final stages of the conclusion for the President and CEO of Pure Sunfarms.

And with the sales license in place, Pure Sunfarms will aggressively move on its product development and branding strategies, including on as I've said. Importantly, even at this early stage in our production, Delta 3 facility is operating exactly as intended. The team has now completed multiple harvest and both the quality of our product and yields are exceeding our expectations. Every day we are benefiting from the deep experience of the growing team, the existing skilled labor force and specific knowledge and advantages that come with two decades of operating a very large scale greenhouse, including years of understanding the microclimate that's unique to the Delta facility, provides us with a tremendous advantage and significantly derisks our production ramp up. That said, I'm not surprised.

Growing any crop of this kind on a massive scale is a complex and challenging undertaking. That's what Village Farms has been doing successfully for thirty years. We are also extremely satisfied with the performance of the nursery and its ability to keep pace with our expansion. In fact, we now know the nursery not only has capability to supply our Delta three facilities, but also other facilities and other producers as well. Conversion of the remaining 1,100,000 square feet continues to progress right on track and we continue to expect the entire 1,100,000 square feet to be converted by year end with the majority of that approximately 75% in production through the winter and full production beginning in the second quarter of next year.

As a reminder, October to March, as per our plan, production will be temporarily suspended in Quadrant one at Delta three, the quadrant we are currently growing in as we go back and install the light fixtures. Quadrants two, three and four, 750,000 square feet are all being converted with lighting right from the start. The rented generating equipment to power supplemental light through this coming winter is on track to be operational by January. As a reminder, next winter, we have secured 24 megawatts of permanent power from the local utility, which will be operational for Delta three by December 2019. Village Farms has also secured another 24 megawatts of power should we decide to use it in 2019.

Before I turn the call over to Steve, let me touch briefly on our incumbent produce business. Revenues of $42,000,000 was down about 8% year over year, mostly due to both low volumes. In Canada, we have not fully replaced capacity from the transfer of 25 acres at Delta 3 facility at Pure Sunfarms. In The U. S, volumes were impacted by planned maintenance at our Monahan facility.

We took it out of production to do a full cleanup for the first time since 2012. So we'll be out of production or we were for about a quarter. Record temperatures in Texas and some weather related damage affected one of our facilities and some of our production. So but that said, profitability this year continues to be impacted by significant higher freight costs, which were up actually 10% year over year, freight being in our cost of sales as The entire U. S.

Economy struggles with limited trucking capacity in the wake of new regulations. In addition, we're still monitoring potential changes to NAFTA where negotiations continue and investing in more local housing in Texas to offset increased labor costs and availability. Our produce business continues to focus on maximizing margins through exclusive high margin varieties and low cost production as we provide the highest quality and safest produce to the leading grocers across The U. S. And Canada, which we've done for thirty years.

As I've said many times, Village Farms' years of experience driving that cost and our green aspirations will be of tremendous value to Pure Sunfarms going forward. I'd now like to turn the call over to Steve to walk through our financial results in detail. Steve?

Speaker 2

Thanks, Mike. Our complete second quarter and year to date 2018 financial results and discussion are available on SEDAR. All BSA were not posted until this morning due to SEDAR system wide issues that all filers experienced yesterday. I'm happy to go into more detail in the Q and A at the end of the call. I will remind you that most of the numbers I will discuss are in U.

S. Dollars. When I discuss Pure Sunfarms, I will discuss Canadian dollars. Sales for the 2017, as Mike said, 42,000,000, down 8%. The decline was primarily due to lower volumes.

Mike has already discussed. Overall cost of sales for Q2 decreased 3% to 41,200,000.0 $42,800,000 primarily due to the decrease in volumes as well as the decrease in third party contract sales costs, which was offset by, as Mike said, increased freight expense and increased labor costs at both our Texas and BC facilities. Selling and other general and administrative expenses for Q2 increased 5% to $3,400,000 from $3,200,000 primary related to higher public company related activities such as Investor Relations, legal and listing fees in the 2018 versus 2017. We reported a net loss for the 2018 of $2,300,000 or a loss of $05 per share compared to a net profit of $4,300,000 or $0.11 per share in Q2 of last year. Last year was primarily profitability was primarily driven by an $8,600,000 book gain recognized on the contribution of the Delta 3 facility to Pure Sunfarms in June 2017.

Our EBITDA for Q2 was a negative $1,300,000 compared to a positive $1,300,000 in the same period last year. Since our full financials were not posted until this morning, in all likelihood, no one has had time to read them. And in fact, if anybody actually ever does read them. But I'd like to go into the Pure Sunfarms financials, which are contained in the footnotes of the Village Farms full financials. As most of the people on the call are probably more interested in the Pure Sunfarms business than our fresh produce business.

So I want to highlight a few financial items with respect to Pure Sunfarms. We continue to have lower overheads as our primary focus has been converting facility, getting our Health Canada licenses and building the back office to support our oncoming sales activities. For the quarter, we incurred CAD 761,000 of operating expenses, having incurred CAD 1,300,000.0 year to date of operating expenses. For most of the long term investors of those farms, you've heard me talk about our bio asset accounting, which is required by the IFRS. The cannabis business is no different.

So for the first time on June 30, Pure Sunfarms is reporting and has recorded a bio asset. The bio asset as indicated in Footnote seven of the Village Farms financial statements has a bio asset value of $422,000 as of June 30. This figure essentially represents the gross margin, so that sales value, less cost of production and ancillary selling costs of the buzz on the plants as of the reporting date on June 30, which was very limited and essentially was one flower room on the reporting date of June 30. Pure Sunfarms did not value as others do and are allowed to do the full value of the plants in the facility. So the plants in the nursery, for instance, are carried at cost and are not contained in the biological value.

So Pearson Farms has valued just the buds on the vine, which for the most part have either been sold or being the process prepared for sale. So while a very small sample of what's forthcoming, the initial production is profitable and we expect to report positive net income from Pure beginning in Q3. And Pure Sunfarms will be generating positive cash flow from operations in Q4 and generating excess cash flow starting in 2019. That concludes my remarks and I'll turn the mic back over to Mike.

Speaker 1

Thanks, Steve. We are now just 62 from federal legalization of adult use cannabis in Canada. Village Farms drove 50% ownership of what will soon be one of the largest cannabis production operations in Canada and perhaps Wells on the verge of transforming its earnings trajectory in the process. In many ways, we have taken a differential path to get where we are today. We ended the industry later than many of the other large LPs.

We entered the industry underpinned by a $200,000,000 a year produce business. We've been very capital efficient, converting existing greenhouse facility operations and pursuing a partnership model. As a result, we've had limited shareholder dilution. I'm proud to be able to say that Village Farms has been able to achieve everything it has in terms of Pure Sunfarms without hiring a single additional person within the organization. All of this, we believe, will contribute significantly to shareholder value as we expand production and drive revenue and cash flows from Pure Sunfarms.

Pure Sunfarms has had to prove itself every step of the way, conversion, licensing, production and sales all within less than a year. As we continue to do so, we will continue to ramp production up as we ramp up sales and as we've been to generate positive cash flow, which we expect to do shortly. I am confident that Pure Sunfarms and Village Farms as an owner will begin to recognize for the significant long term value what is being generated. With that, I'd like to open up the call to any questions.

Speaker 0

We will now take questions from institutional investors. Your first question comes from Russell Stanley with Echelon Wealth Partners. Please go ahead.

Speaker 3

Good morning, guys.

Speaker 1

Good morning, Russell.

Speaker 3

Congrats on the progress. I guess my first question with respect to quality and yield, can you talk about I guess what your current yields are and how that reflects or inputs your informs your production estimates for this year and next?

Speaker 1

Well, I think the second part of the question I'll answer the second part. I mean, we feel very confident about the production yields we put out for both this year and next year. So what we're seeing makes us feel extremely confident. But we're in the midst of conversion and it's very hard to put out yields based on one harvest. As you remember, we're doing 85 once we ramp up, it will be 85 harvests a year and 17 grow rooms, roughly five, five point five per room.

So we really need to get a lot more traction before we can look at where the yields will start leveling off at that point. But I can say that we are confident in exceeding our expectations that we put out.

Speaker 3

Excellent. And with respect to quality, I guess, you comment or provide some color as to how you're measuring that against what you were expecting?

Speaker 1

Well, it's still early in the game. But I mean, we've had 100 harvest of meeting our specifications and what we anticipate the specifications in the market. So basically, we are harvesting everything we're growing and it's meeting the spec we've had. Even to our sort of surprise, we've had no shrink whatsoever and that quality spec is being met. So and if we judge it from what we're hearing from the customers we're selling, there's no issues at this point in time.

And keep in mind that we have to go through a whole year cycle because growing in the summer or during the summer is much different than growing in the fall and winter. So we really need to get some more traction again where we can say that with confidence on a full year cycle. We also are we're increasing our strains that we're growing to have a good choice on where we want to focus and what strains we want to focus on both THC strains and CBD strains. But we definitely need more time to get through that Russell.

Speaker 3

Okay. That's helpful. And just I guess switching gears to the sales side. Not sure what detail you can provide, but any color on who you're selling to at this point?

Speaker 2

At this point, we are selling to other LPs. Obviously, Emerald is included on that list. We've announced that supply agreement. We are selling to other LPs, my word, on a spot basis as the product is available. People are essentially bidding for it.

With respect to everyone has seen BC has announced a new RFP proposal. So Pure Sunfarms now has a sales license. We'll essentially be putting in products by the end of the month as requested by the BCE Liquor Board. So we're looking forward to selling product to them based on however the rollout goes in BC.

Speaker 3

Great. And I guess that dovetails into my last question. You mentioned BC. I guess can you talk a little bit about beyond that where your geographic sales priorities are at this point as far as the provinces are concerned? I'm assuming Ontario is there, but can you I guess elaborate on where else you might be looking?

Speaker 2

We're ramping up. And as Mike mentioned, the executive for Pure Sunfarms is getting close. And he and his sales and product development team will be making those decisions as we go forward.

Speaker 1

Right. And keep in mind, we still have as we projected for 2018 with about 7,000, 8,000 kilograms that we don't start to ramp up really till we get into 2019. We certainly don't want to be out there overcommitting till we have the quality of the product. So working in BC where we're located makes the most sense at this point in time. Great.

Speaker 3

That's great. Thank you for the color and congrats again on the progress.

Speaker 1

Thanks, Troy. Thanks.

Speaker 0

Your next question comes from Bruce Schindler with Stockbridge Associates. Please go ahead.

Speaker 4

Hi, fellows. How are you today?

Speaker 1

We're good. Hi, Bruce.

Speaker 4

Good. I want to congratulate you on the great progress and this incredible timing on the sales license that came so fast. I am an investor in other companies and I know they're waiting eight to twelve and in some cases over a year for that sales license. I'd also like to congratulate you on increasing with great more than the value of that working relationship.

Speaker 1

Thank you.

Speaker 4

In in particular, I'd like to in the Ashland report that I'm sure you've read that came out, I believe, on Monday, it talks about this 40 that Emerald has committed to. I'd like to know, is this cast in stone and in writing and part of your JV that Emerald gets off the top 40% of production of the smaller amount in 2018 and of the larger amount in 2019? Is that cast in stone?

Speaker 2

Bruce, this is Steve. It's not in the shareholder agreement. It's a separate supply agreement that we entered into on behalf of Pure Sunfarms for the periods 2018 and 2019. But it is not a requirement of the shareholder agreement. It was a separate arm's length transaction between essentially two LPs, Pure Sunfarms and Emerald.

Speaker 4

Okay. And next I'd like to ask about the next 25 acres potentially, I'm sure you have enough on your plate obviously in expanding all the footage in Delta three, I guess is what it is. But can you give any insight into the 25 acres and how those conversations might be coming along?

Speaker 1

I can. Well, first of all, the Village Farms gave Pure Sunfarms an option for the existing other existing facilities, Delta one and two, one being Delta two being 25 acres or another 1,100,000 square feet and Delta one being 60 acres or almost 3,000,000 square feet. Those options cannot be triggered under the shareholder agreement until such time that Delta three has its full cultivation license for the full 1,100,000 square feet, whereas we've said, we're looking at year end for that to occur. But Village Farms' view is that we have opened those discussions up because we can provide a wave at a Pure Sunfarms should they want to move on that option sooner. And all I can say is we've put that forward and there's been no decision as of yet.

Speaker 4

Okay. It just seems to me that do we believe Emerald is having any financial problems or anything since it was clear in research that nothing is going to happen in their Richmond facility. They've been turned down twice. None of our group at Stockbridge can figure out what they did in Quebec and

Speaker 1

Well, I can say though, Bruce, that has nothing to do with Pure Sunfarms and nothing to do with Village Farms. So I really don't know what you would have to refer to Emerald because we have no knowledge or information of that. And would rather not just their business. So I know that I can't say Pure Sunfarms is looking down the road. It's not restricted to operate in any other country as an entity.

And it is also looking at opportunities within Canada as well to what we're doing in Delta or may do in Delta. So that's all I can really say about that Okay. At this

Speaker 4

Well, that's very enlightening. I have one question. Some of the figures I have seen is when this 1,100,000 feet is built out based upon projections only, that would equal about 5% of the growth in Canada and that was done by a fellow at Pacific, I forget the exact name of the research house. Do you concur with that? If you had seen that report, I think it was out about three

Speaker 1

years Yes. I've seen that before, but I guess really it really depends where the market is going to be in two years. So but I would say within 5% is probably a good number based on what we think our ramp up will be in 2020.

Speaker 4

Okay. Well, thanks very much and a wonderful report.

Speaker 1

Thank you.

Speaker 0

There are no further questions at this time.

Speaker 1

Okay. Want to thank everybody for joining this conference call, and we look forward to reporting on our progress over the next couple of months going forward. Thank you.

Speaker 0

Thank you. This concludes today's conference call. You may now disconnect.