Village Farms International - Earnings Call - Q2 2020
August 13, 2020
Transcript
Speaker 0
Good morning, ladies and gentlemen. Welcome to Village Farms International's Second Quarter twenty twenty Financial Results Conference Call. Yesterday, Village Farms issued a news release reporting its financial results for the second quarter ended 06/30/2020. That news release along with the company's financial statements are available 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 the completion of today's 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 the company's various securities filings with the SEC and Canadian regulators, including its Form 10 ks MD and A for the year ended December 3139 and the 10 Q for the quarter ended 06/30/2020, which are available on EDGAR.
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'd now like to turn the conference over to Michael DiGiglio, Chief Executive Officer of Village Farms International. Please go ahead, Mr. DiGiglio.
Speaker 1
Thank you, Jack, and thank you everyone for joining us today. With me on today's call is Village Farms' Chief Financial Officer, Stefan Raffini. Today's call begin with a review of the highlights of the quarter, most notably the sixth consecutive quarter of profitability for Pure Sunfarms as well as positive EBITDA in our produce business. Steve will then review our financial results and I'll return briefly to discuss why we remain so confident in the future of our company and we'll then go open it up to Q and A. Before I begin with respect to COVID-nineteen, I am again pleased to report that all of our Village Farms and Pure Sunfarms facilities in Canada and The U.
S. Have continued to operate uninterrupted as they have since the start of the pandemic. We have experienced an extremely small number of COVID nineteen illnesses at two of our four produce facilities in Texas only. However, appropriate protocols will follow and have been no material disruptions to our operations. Our success to date in managing the challenges of the pandemic is a testament to our adherence to the recommendations of health authorities at all levels of government which are over and above the already high standards of hygiene practices and safety protocols already in place as a highly regulated fresh food producer.
In fact, other than the slowing of the build out of provincial retail cannabis infrastructure and its effect on industry sales, COVID nineteen has had no material negative impact on our operations to date. And at this time, we don't foresee any lasting impacts going forward. So before I start my scripted remarks, just want to say how important this most recent quarter was for us and how pleased I am with the results. We proved clearly that Pure Sunfarms can lead the Canadian cannabis market with the highest quality products at aggressive pricing and deliver profitability. It is clear evidence of the long term durability of our business.
Now on to the highlights for the quarter, starting with Pure Sunfarms, of which I remind you, we own just under 59% as of the beginning of the second quarter. So the second quarter continued to demonstrate the earnings capability of Pure Sunfarms, the direct result of transitioning existing low cost, large scale, technologically advanced growing operations to cannabis production. Thirty plus years of experience in vertically integrated intensive agriculture. The best management team in the industry at Pure Sunfarms approval approach to SG and A, a pragmatic well thought out approach to brand and product positioning and an overriding focus on cash flow generation and a clear understanding of what is required to compete in the Canadian market. In Q2, we generated our sixth consecutive quarter of positive net income and our seventh consecutive quarter of positive EBITDA.
That's every quarter since we started shipping cannabis at scale, which was back in 2018. And we achieved this while transitioning from selling entirely into the wholesale market to now predominantly branded retail sales. All in cost of production per gram for Q2 and I will once again emphasize that this includes depreciation and also includes packaging logistics, it's all in cost was CAD0.84 per gram. This brings Pure Sunfarms average all in cost per gram for the last four quarters to CAD0.80. While we're obviously pleased to continue to lead all Canadian public greenhouse and indoor producers in this important metric, most by a fairly wide margin.
We are also confident that we can still bring this number down further as we continue to refine and enhance our operations and especially as we bring our own extraction operations online, grow new strains and further hone our growing techniques. The ability to grow high quality cannabis at an industry leading cost is clearly a competitive advantage for Pure Sunfarms providing significant pricing power while still generating profitability. I want to mention here that we are currently evaluating if we're going to continue to provide cost of goods sold on a per gram basis going forward. It has never been to our advantage competitively to have this number in the public domain. We do not provide it for our produce business for this very reason.
Having established ourselves as a low cost leader and with a proven track record, we are of the mind that gross margin, net income and EBITDA figures going forward should suffice as a measure of our operational performance. At the top line, Retail Branded sales for Q2 was slightly up on a dollar basis from the first quarter of this year. However, sales volume increased 89% from Q1. As we ramped up the introduction of our large format value products, which I will discuss more in a moment, It is important to note that we still generated a 33% gross margin in Q2 even with our aggressive pricing strategy and the shift in sales mix to a high proportion of large format product. This is a very, very important takeaway takeaway in this quarter.
And we also demonstrated with this aggressive pricing, again, because we must compete with the illicit trade, we can impact the market. We are seeing this momentum continue with a solid start to Q3. I will note that July was a record month for sales of Pure Sunfarms products by the Ontario, Alberta and British Columbia provincial boards to their retailers and through their own websites. Wholesale sales as expected were down sequentially from the outside levels of outside levels in Q1, which included some large non monetary sales through extractors in which we exchanged flower for distillate. We are seeing an uptick in sales activity to other licensed producers.
We believe this to be a result of the continuing challenges that some of our other producers are having around growing quality cannabis at scale and at a viable cost of production. We mentioned previously that one of our corporate goals is to retain 20% market share of the Canadian market while providing 35 of the cannabis supply. And I'll note again that when comparing Pure Sunfarms Q2 results to those of last year, the entirety of Q2 twenty nineteen sales were wholesale sales, no retail, prior to the receipt of our license to sell directly to provincial boards and enter the retail market. Recall that this was a wholesale market pricing was was at its peak shortage of product at that time in the neighborhood of three current wholesale spot price. That was just one year ago.
That said, in the current environment, we are seeing the will pay for the right and high products. So ahead, notwithstanding any additional impact from the COVID pandemic that may have on the broader market, we expect this second half of the year for Pure Sunfarms with a number of potential growth drivers. Those drivers being first, legal cannabis market all continues to grow. Now at a run rate above $2,000,000,000 more than two and a half times where it was just a year ago. This will be increased supplemented by conversion of illicit market consumers as price, quality, safety product, selection and access to more retail stores in the legal market continues to improve.
It's worth noting here that the OCS reported that in the 2019, more than 80% of cannabis consumed in Ontario was still purchased in the illicit market. That's more than 80% just months ago. This proves an excellent reference point for the size of the opportunity especially for those who have a leading share in the legal market. We have made it for one of our have made it for one of our clear priorities since launching retail to lead the conversion of traditional users into the legal market. We believe this is ultimately how the majority of traditional users want to purchase provided they can find easy access to quality products at an attractive price point.
Secondly, we are seeing momentum in a number of bricks and mortar retail stores across Canada, especially in Ontario. Obviously, this will benefit many suppliers, but clearly Pure Sunfarms stands to benefit disproportionately given the strength of its market share, again especially in Ontario. Third, we continue to launch new products in the dried flower category, which still by far is the largest market and probably for the foreseeable future. And then rounding out its SKUs in terms of package size and adding two new strains, two exciting new strains including high THC strains this quarter. We've entered the market with aggressive pricing and our large format value products have consistently ranked among the best selling dry cannabis products with the Ontario cannabis store since their launch at the '1.
Fourth, we expect Pure Sunfarms will continue to add new provinces. It began shipping to Saskatchewan at the end of Q2 and Manitoba last month as well. These two provinces added access to an additional 10% of the Canadian market. Pure Sunfarms products are now available in five of the six largest provinces which make up 70% of Canada's population. The majority of the remaining 30% is Quebec so clearly that market is a high priority for us moving forward.
Finally and most importantly Pure Sunfarms will start shipping its first bottled oil and other two point zero products for retail sales beginning with its three largest markets imminently. And we will continue with our aggressive pricing strategy while continuing to elevate quality and offer products that consumers want. It is a proven winning proposition. It is also a necessity to capture share from the illicit market. This is how to compete in the Canadian marketplace.
Importantly, Pure Sunfarms will enter these new categories on the back of its continued leading market share in dried flower. Our strategy was to first establish a commanding position in dried flower, which still dominates the market as I said before entering new categories. I am pleased to report that for Q2 Pure Sunfarms was once again the top selling dried flower brand by volume with the Ontario cannabis store, which is shy of 14%. That marks three consecutive quarters in which Pure Sunfarms has been the top selling brand every quarter since Pure Sunfarms entered the retail branded market in late September last year. And I'm smiling as I say that because it's an incredible accomplishment by the Pure Sunfarms folks.
In fact, if we look at the data all the way back to October 1 through the July, a ten month period, Pure Sunfarms still ranks number one. I just wanna pause on this for a moment. Since October, Ontarians have purchased more Pure Sunfarms dried flower product than any other brand. I would like again to congratulate the team at Pure Sunfarms. It's a tremendous achievement.
Amidst a rapidly evolving market with a continuous stream of new product introductions, Pure Sunfarms has consistently had products in the number one, number two, or number three spots for dry flower, often having multiple products among the five best selling products. It's worth noting that Pure Sunfarms has achieved this with no major promotional expenditures, no celebrity partnerships or endorsements, no media hype, just great brand positioning executed by second to none management team. It's one of the reasons SG and A remains low. As I have discussed many times, this is a direct result of Pure Sunfarms strategy, high quality products that consumers want at an attractive price. And I will add that we weren't all surprised when a recent survey found that more Canadians believe the best cannabis is grown in British Columbia than any other place in Canada and in fact is world renowned.
It isn't folklore. As growers, we know that BC is hands down the best location to grow cannabis in Canada and that matters to the quality of the product. Selecting the best growing region is critically important. Like Bordeaux in France and Napkin, California, geographical location for growing matters. It's not about the location you have, it's about having the right location.
As I've discussed on past calls, we don't get the same level of sales detail for the other provinces in which we sell. But based on the data we do have, we continue to see strong brand and product performance in Alberta and BC, which we've just recently started shipping to both provinces. The biggest challenge right now for Pure Sunfarms as it is for all suppliers is that there are simply too many producers in the market for the size of the legal market, upwards of 50 in some provinces. And there appears to be an interest on the part of the provincial board at least in the short term to spread their budgets around. That said, the market is steadily growing and the supplier landscape will shake out, it has to.
There are too many producers that simply don't have a durable business model, too many producers that are not able to grow quality or grow at a viable cost and too many producers are consuming their balance sheets quarter after quarter, year after year. In the interim, we have temporarily scaled back production at Delta three to better align our output with sales for the next term. With 16 grow rooms in Delta three, we have the flexibility to easily and quickly adjust product volumes as well as products we are growing. We are focused on cash flow generation and therefore how much we can sell, not how much we can grow. Recall that Pure Sunfarms goal is to capture at least 20% of the dried flower market in Canada over the long term, a level was achieved that we actually achieved in the month of April in Ontario.
And we remain confident that as the Canadian industry moves beyond its startup phase and operates as a mature efficient market, this goal is well within reach. Our industry leading greenhouse cultivation costs will continue to be a significant advantage in support of further market share growth in the legal market and of critical importance capturing meaningful share from the illicit market. Competing directly with the illicit market is what will truly drive sales. It is the key near term strategy for Pure Sunfarms and the tactics to achieve this are in place, working and validated. Again, this positions us very well for the launch of our bottled oil and two point zero products in the very near term.
So quickly about our produce business. Turning, Village Farms has had a strong second quarter delivering nearly a $6,000,000 year over year turnaround in adjusted EBITDA to generate positive $1,200,000 EBITDA. The increase was a result of a number of factors. First, we continue to make steady progress in our strategy to transition our own growing capacity that we displaced for cannabis to partner growers in both Mexico Second, we continue to focus on cost management. And third, we benefited from higher pricing due to the elevated consumer demand resulting from more consumers now eating at home.
The vast majority of our produce business is through grocery stores and not food service. Pricing has remained strong in Q3. This is especially encouraging given that the organization that underlies our produce business is the engine that is driving our next phase opportunities as we continue to position Village Farms for the evolution of cannabis and CBD both domestically and internationally. I wanna note here that since entering the cannabis space back in June 2017, Village Farms has not hired one additional person to pursue these opportunities. We have leveraged the breadth and depth of capacity of our existing organization with our produce business paying the overhead to pursue this outsized potential.
It really underscores who Village Farms is at its core, a vertically integrated company that continues to produce high return agricultural based products. So going on quickly to The US CBD and cannabis. In The US, we continually closely watch and are active in the regulatory developments around CBD. We are somewhat encouraged by the FDA's recent comments about providing a clearer regulatory framework around the use of CBD in products as well as the prospects for federal legalized high THC cannabis in The USA. With one of the largest greenhouse footprints in North America, we can move instantly on either of these markets and already having a head start on a conversion of our Permian Basin facility.
We intend to be a major force in The US market. We recognize the FDA's other priorities at the moment however, we also believe the agency recognizes the importance of providing a clear path forward that will allow companies large and small to make prudent, well informed, risk mitigated decisions to enable the industry to flourish and prosper to its full potential. Let me be clear. We are currently in a holding pattern, but we are fully committed to the CBD market. We have just seen too many companies struggle with vague regulations in broader industry that is significantly hamstrung by the resulting risk.
We are simply being prudent. We don't need to be in the market now and we won't put our shareholders at risk. On an international side, Pure Sunfarms is clearly and consistently executing on plan in Canada and we believe is well positioned for growth for years to come as one of just a few large industry suppliers that will dominate the market. This has enabled us as a management team at Village Farms to turn our attention to existing to extending our international reach always with a focus on prudent capital allocation for well researched opportunities with outside potential returns both short and long term. We took our first step in July when acquisition of just under 16% of The Netherlands based business called Dutch Can Grow.
Dutch Can Grow is a consortium of partners with various expertise that has applied for license become one of no more than 10 licensed suppliers to somewhere around 80 cannabis shops, known there as coffee shops in the 10 cities under the experimental government program. These 10 cities will comprise the first legal recreational cannabis market in Europe. The intention of the program being to improve the safety of cannabis products in The Netherlands and curb the criminal involvement resulting from the current illegal climate of growing and supplying products to The Netherlands. There are many companies vying for just a few licenses, but we are optimistic about our prospects based not only on the outstanding group of partners at Dutch Can Grow but the specific cannabis experience in Canada that we bring to the table. While the long term possibility that the program could be nationalized to more than 500 coffee shops, this opportunity is meaningful in and of itself but we also view it as a potential springboard to other legal cannabis opportunities especially in the European markets.
And, you know, obviously, we realize these these are long term decisions and we're excited about that. Some of these markets may take years, to develop, but it's important that we stick a flag in the ground now and that's what we're doing. And then also we recently acquired 6.6% of Australian based Altium International, which is one of Asia Pacific's leading young new CBD platforms with high THC cannabis opportunities in Australia and New Zealand with the option to increase their ownership. Altium is pursuing the Asia Pacific market via three channels, proprietary consumer brands, commercial CBD ingredients for foods, beverages, cosmetics and other consumer packaged goods and educational experiment at retail stores for both Altium's own and partner products. They are already off to a great start in Hong Kong, which has one of the most progressive regulatory environments for CBD and are building out their presence in other large target markets.
We are actively exploring other international opportunities that will leverage our Canadian success to date in Canada. And I do want to take this opportunity to remind you that our international that our Village Farms International Farm 2,600,000 square foot Delta One facility adjacent to, the Pure Sunfarms greenhouse facility is available to transition to CBD or high THC cannabis for export should Pure Sunfarms choose not to exercise its option in that facility prior to the expiration in September 2021. I'd like to turn the call over to Steve and he'll take us through the results financial results and summary. Steve?
Speaker 2
Thanks, Mike. I will review some headline figures from our Q2 results by business line. First, produce, while not the business line that most want to talk about, is our historical business and base business as we move into a new agricultural based CPG business line. Our top line Q2 produce sales increased year on year by 15% in U. S.
Dollars to $47,600,000 from 21,300,000.0 with cost of goods sold relatively flat year on year, resulting in an improvement in our gross margin of 6,500,000 from 2019, providing a gross margin percentage of 7.4% in the 2020 versus a negative gross margin in the 2019 of 7.2%. Historically, Q2 has been a tough quarter for our produce business due to the dynamics of the North American tomato supply business as all U. S, Canadian and Mexican greenhouse producers are producing in this three month period. Basic economics presides. Higher supply in a relatively flat year round demand business results in historical challenging market pricing in the spring and early summer months, year in and year out.
But historical dynamics like many things in 2020 have been turned on their head, in our case to the positive. We are experiencing increased demand consumption from our retail customers, who as Mike mentioned, our big box grocery store national grocery store chains, as most people are staying at home and eating at home, while tomato supply around the world has its own issue with its own virus, which is resulting in lower tomato supplies. So basic economic one zero one is occurring, increased pricing. Year on year, our q two twenty twenty average tomato pricing increased 39% from our average price in 2019. The increase in pricing was even more prevalent in our large commodity tomatoes, beefsteak and TOV, as we have seen an increase in consumption in larger tomatoes since the outbreak of coronavirus.
A reversal of the consumer trend over the last few years to smaller, higher priced, more flavorable tomatoes. We're forecasting a continuation of strong year on year pricing resulting in positive EBITDA and cash flow from our produce business, which bear is bearing all the cost, public company cost of of Village Farms for the remainder of 2020. Now to the headline cannabis business. For the new investors, our cannabis business today or for the new investors today, our cannabis business is solely through our Canadian joint venture Pure Sunfarms. While Village Farms owns 58.7% of Pure Sunfarms, we cannot consolidate it as we do not control it.
As such, Pure Sunfarms financial results only show up in the Village Farms statutory results as a one line item in our income statement and a one line item on our balance sheet. We do show the full Pure Sunfarms balance sheet and income statement for the quarter and the six months ended June 30 in US dollars in our financial footnotes, which are available in our 10 Q, which was filed last night, which was public as of this morning. Pure Sunfarms saw a substantial decrease in sales margin and EBITDA in Q2 twenty twenty when compared to Q2 twenty nineteen. The market conditions, the Canadian market and demand and supply aspects have clearly changed materially in the last twelve months, and not due to coronavirus as some have blamed. As such, comparing our Q2 twenty nineteen and q two twenty twenty, results, is not indicative of the progress Pure Sunfarms has has made.
In q two twenty nineteen, the marketplace was 100% wholesale. Everything Pure Sunfarms producing essentially was was being purchased by other LPs in anticipation of cannabis two point o, as well as, the expectations by the Canadian marketplace of continued quick rollout of provincial retail outlets which did not occur. Jumping to a year later, we have a total different marketplace dynamics. We clearly have too much supply and as Mike mentioned, too many suppliers. Hence, the average retail channel price in Q2 twenty twenty is less than half of the Q2 twenty nineteen wholesale price, that we received, resulting in a material change, when you look at our results on a year on year basis.
A better comparison is comparing Pure Sunfarms sales in Q2 to 2020, but that too did experience a substantive change due to the both the compression of demand as a result of store closures and stay at home orders in Canada, but primarily driven by the demand for the large format product versus the small format product, which historically had or at least historically for six months had been, the driver of our business. As Mike mentioned, quarter on quarter, the provincial retail sales volume increased 89%. This was driven by the large format, lower priced SKUs, which were a predominant product sold in q two, which was 80% of our sales in q two. Provincial the large format. But as a result show, still a very profitable business for us on which is reflected in gross margin.
As Mike has mentioned, with respect to our cost per gram metric, which is not an industry standard by any form of the imagination, We did provide that this quarter. But as Mike mentioned, we probably will stop providing that, as it's not a great comparison. When one compares Q2 twenty nineteen to 2018, the 2020 cost of goods per gram was CAD0.84 versus last year's CAD0.65 per gram. Last year was 100% wholesale, so it doesn't involve any packaging or logistics costs. In 2020, with predominantly most of our volume going to retail, which will probably be the case, from now going forward, the our cost of goods sold will reflect packaging, logistics, as well as increased post harvest labor involved with handling and treating the post harvest flower and trim, which will become more prevalent as we enter cannabis two point o in the third
Speaker 3
quarter. Okay.
Speaker 2
Just one other quick note on our balance sheet and cash flow, which tend to get overlooked by the headline cannabis business. Our for the six months ended 06/30/2020, Village Farms had positive cash flow from operations of $2,000,000 versus a $9,000,000 cash outflow for the six months ended 2019, an impressive $11,000,000 turnaround. Village Farms is sustaining itself from its produce business. We're not diluting our shareholders or raising cash just for the sake of supporting ourselves. We were able to fund the two acquisitions and or not two investments, as Mike mentioned, in Holland and Asia from our produce cash flow.
And we look forward to continued strong final six months of the year. With that, I'll turn it back over to Mike.
Speaker 1
Thank you, Steve. So we are now at a place where we can really see the future of Village Farms coming into focus. We are realizing our vision to become a highly profitable plant based consumer packaged goods company, leveraging our decades of experience in large scale, low cost intensive agriculture and our vast organizational capabilities as a vertically integrated supplier to the North American major grocers and big box retailers for emerging, for new and high value opportunities. At Pure Sunfarms, our plan does not change from day one. Lead the industry as a low cost producer of quality product, establish and grow a leading market share and drive cannabis, leverage that brand performance for other large product categories and do it with consistent profitability.
We look forward to watching Pure Sunfarms build on its success with the imminent launch of its cannabis two point zero products and the Canadian industry still continues to grow. We are at the leading edge of the global cannabis frontier and this is a massive opportunity and we are proud to already be one of the most successful companies in the world in this new industry, but also excited about our many future opportunities at home and abroad in CBD and in cannabis and that will drive shareholder value in the near term, midterm and longer term. And I just want to reiterate my opening comments about how pleased I am with the Q2 results. They clearly show the earnings power of Pure Sunfarms and how this part of our business will continue to deliver value for our shareholders. We pushed the envelope on pricing in the second quarter to demonstrate that we can compete with the illicit trade day in and day out and be profitable.
That is a huge demonstration. And with that, we will take any questions that you may have. Certainly.
Speaker 0
This time if you'd like to ask a question please press 1. Aaron Grey with Alliance Global Partners your line is open.
Speaker 4
Hi good morning and thanks for the questions. I guess, you know, first one from me and also congrats on another, you know, quarter of profitability for Pure Sunfarms. But, know, first one from me as we look at the top line on the retail side specifically, you mentioned, you know, still doing well in Ontario with 14% market share, still in the early days of Alberta and BC. But specifically with those two provinces, you mentioned a lot of competition and competitors there. So just wondering if you could give some color in terms of how much that's kind of impacted the repurchase rates there?
And if it's kind of going to take some of the shakeout before you see more meaningful contribution from those two provinces? Or just any color there in terms of how we should expect kind of ramp up in those two provinces to come? Thanks.
Speaker 1
Well, you can't forget that the second quarter was an interesting quarter because of the pandemic. What happened towards the end of the first quarter, February and clearly March, there was a huge purchase at the provincial levels, a lot of pantry hoarding was going on. And that's had an impact sort of at the beginning of the second quarter, especially April. You know, that so when we look at the second quarter, you know, there were a lot of things that are that were impacted due to the coronavirus, and it started to smooth out, you know, halfway through the second quarter. But remember that we didn't really in March is when we launched in BC with our large format and we actually launched in the OCS on fourtwenty in April, so tied to that date.
And then Alberta followed. So a lot of this a lot of our impact really started as far as sales increases towards at the middle to the end of the second quarter. And now going forward, this will be the first full quarter that Alberta and Saskatchewan are on. A large format is in all those provinces and I think we'll start we'll demonstrate that traction in the third quarter going forward.
Speaker 4
Okay, great. Thanks. That's super helpful. And then if I could just ask one more on the gross margin side. Certainly makes sense how we saw some pressure sequentially as you rolled out your value formats.
But a couple of things here. As we think about more value offerings coming online and then also potentially two point zero products and then also it seems like you have some opportunity on the cost per gram side. How to kind of think about the puts and takes in terms of the gross margin evolution over the next couple of quarters? Thanks.
Speaker 1
Well, I think this will be the lowest I think the second quarter look, we pushed the envelope in the second quarter and because at the end of the day, we've always said that for us, it's about taking cannibalizing the illicit trade. That is the market as we see it. And whether it's dried flower or vapes, which we'll soon be launching, you know, we have to go through the cards were dealt with in Canada, the Canadian market is very different than any other market. All these international markets will have uniqueness to them. So Canada is very different from The US.
The cards we're dealt with in Canada are that one, as I've said many times before, we have to pay a huge amount of taxes. Our taxes for our licenses, which is based on revenues, will slowly in the next six months be close to a $05,000,000 a month. We pay $1 gram excise tax. There has to be a strong margin for the provincial boards to make, and then we have to make our margins and be profitable. And the second quarter demonstrated that if we're gonna take the market share from the illicit trade, which is clearly, as I mentioned, 90% of the existing market, we have to compete with that.
In The US, that's not the case. You know, less and less the illicit trade is less and less of a issue in The US market, but it's clearly there in Canada. So regardless of so whatever the gross margin came out and we were very pleased that it came out north of 30% which I think will be the very low end of the scale going forward, we demonstrated that we can survive, be profitable, be cash flow positive and take market share. I mean, we were able if the market moved five or 10 from the first or second quarter, we were able to increase our sales 90%. That really shows the power of being aggressive in pricing.
I'm not even sure aggressive is the right term. It's a requirement to compete with the illicit trade. So as we introduce more single strains that have drivers like high THC that commands a greater price, as we deliver our two point zero products that have higher gross margins, those numbers should be increasing. So I think this quarter, as I said, was a huge quarter to demonstrate that we can be viable at these prices and be profitable. Then I think we'll show that going forward.
Speaker 4
Thanks for that color. That's helpful. And I'll jump back in the queue.
Speaker 0
Andrew Partheni with Stifel GMP, your line is open.
Speaker 5
Thanks for taking my questions. I wanted to touch on a little bit of the dynamic of the provincial boards, their purchasing and the stock levels. I mean, you guys are obviously doing exceptionally well, with sell through, you know, with the with the stats that you mentioned, PSF being the best brand in Ontario. But, anecdotally, I've seen, at times that your your product, is out of stock. Could you maybe touch a little bit on that, provide a little bit of extra color with regards to, you know, inventory levels?
I'm wondering, you know, if if the provinces kind of increase their their repurchasing of your product given it's so popular, that your sales could could, especially in this quarter, have been significantly higher?
Speaker 2
Yes. I mean, I think this is Steve. Thanks for the question, Andrew. It's a continuing issue. Obviously, we see that, Pure Sunfarms sees that.
To some extent, these provincial buyers are, let's say, not similar in behavior to what we deal with in the produce business, a commercially driven P and L manager buyer who's driven by P and L. These provincial buyers, Ontario as an example, have I think upwards of of over 50 suppliers to flower, which is an incredible number of vendors. So to some extent, and Pure Sunfarms has been told told this, that the provincial buyer has a certain dollar amount that he can can buy, and they have been told in certain instances when something's out of stock that essentially it can't be reordered at this time because essentially the money for purchases has been spent. So to a large extent, obviously, out of stock is a lost sale. That's how we look at it.
That's how Pure Sunfarms looks at it. But to some extent, as Mike has mentioned, the Canadian system is a Canadian system. It is one of the headwinds that all the LPs have to deal with. You're dealing with provincial buyers, not commercial buyers who are necessarily looking at, the case of a produce buyer, dollars per square foot. That's just not how these provincial buyers are currently operating.
That said, they have changed their behavior. Pure Sunfarms is seeing more frequent purchases from what occurred in early twenty twenty and late twenty nineteen, which was large purchases, and we wouldn't see any reorders for a month. Now we're we're seeing in places like Ontario weekly orders, which is which is helpful to Pure Sunfarms and allows it to restock those SKUs that are moving and hopefully avoids over shipping SKUs that don't move. This is a consumer branded goods business at the end of the day. So new SKUs, as the cases which large format can negatively impact existing sales of small format.
That did occur.
Speaker 1
Yeah. And if I could add to that, I mean, we have to understand and be patient that this is a whole new massive industry, and they're feeling their way too. And I think they're doing a great job in just early days here. So so when you see SKUs that are selling well that are out of stock, it's just part of, building a new base business for them as well.
Speaker 5
For that additional color. If I could ask one more, just you know, the expansion of your geographic distribution and adding new provinces. You know, you touched a little bit on that on your prepared remarks, but maybe if you could just, give a little bit more color on, you know, what exactly are you working on to to penetrate additional markets? What's really the the the obstacles that you guys kind of face to turn on that new contract and win that shelf space?
Speaker 1
Well, I think the information we're receiving from the provincial markets that we are in is that we're in a position of one, two, and three in terms of quantity being sold. So, you know, we're very pleased with that. And as I mentioned in my remarks, the final Quebec is really the final major market we want to penetrate, which then will represent 70 to 80% or more than 80% of the Canadian population and that's the only one left. But, you know, I think Pure Sunfarms has been very prudent in making sure they can deliver to each provinces, fulfill the orders, understand what their needs are before they take on another one because as we know, you know, you always wanna deliver. And so I think they've done that.
Although, prudently, they've moved very quickly. And Quebec is is on the radar screen for sure. And I think, you know, god willing, that'll happen pretty pretty soon, and then we'll be where we wanna be more or less. There are some discussions going on with the Maritimes as well, but Quebec is the next big move for us.
Speaker 5
Thanks for taking my questions.
Speaker 1
You're welcome, Adam.
Speaker 0
Adam Buckham with Scotiabank. Your line is open.
Speaker 6
Good morning, Mike and Steve. Thanks for taking my question. Wanted to dig a little deeper on pricing to start. So it sounds like from your comments, you expect to see overall pricing stabilize to an extent moving forward at PSF. So I guess my question is with where PSF now in the product portfolio is now, do you believe that there's any need in the near term for price adjustments to maintain our gross share?
Or do you see the setup the current setup that's hard to match by the market?
Speaker 1
Yes. I think yes to both. Think we don't spend a lot of time really looking at the competition. We just are driving our business model forward. And, we see competing with the illicit trade and understanding that's the industry, that's the market that we have to understand and compete against.
Now if others can't compete at that level, you know, that's that's their issue, not ours, but that's where we're going. And this as I said, this was a demonstration that we can compete day in and day out against the illicit trade while we have all these other cards we have to deal with in terms of the dollar excise tax and and the ability you know, we don't have any ability to use the tools that the illicit trade may in terms of biologicals or the or pesticides and so on. And it's almost like growing, as I've mentioned in the past, with one arm and they tied behind your back. But those are the cards we dealt with. That is the market in Canada, and we have to learn to compete.
And I think they're doing it very well. So with pricing, yeah, they they kinda went to the mat here. And that's why I'm really excited about it because going to the mat and generating north of 30%, which you know, 30 to 50 for a traditional mature CPG business, I mean, that's probably a sweet spot, and this is sort of the low end of that. But I don't see that we have to deliver pricing any lower to compete. We've demonstrated that.
The 90% increase in volume sold supported that we're at that sweet spot. So I think now introductions the introductions of single strains and h and h two o products, Health Canada, you know, the the vape pens and everything else we're delivering will be at higher margins and our average margin will come up. So I think this is sort of the bottom of that range. And not to be redundant, but, it shows where we compete and that gives us a lot of confidence in the sustainability and durability of our business model.
Speaker 6
Those are great comments, thanks. So secondly, I guess at a high level, can you provide some color on just how the cost profile is different between, you know, your wholesale sales, the large format and your other SKUs?
Speaker 1
Probably not too much. You know, that would probably get we don't wanna give too much out to the competition, but, you know, our large format is high quality, and it's very good product. So it's just, we found a way we can do it. Think not saying maybe we were the first to introduce it, but clearly, we've been the most successful in that introduction, and it's resonating very well with consumers. And that's sort of our little bit of our IP, so to speak.
And but we're, you know, we're going you know, we're looking at producing. We're doing a lot of things in our new processing center, hand drying and, you know, coming up with the creation of products that, others may deem more of a craft side. And, so we have a full array to meet all consumer needs going forward. But the bulk I think the bulk of the market still remains flower and the value added pack is still gonna rule going forward. Okay.
Speaker 6
That's great. I'll just squeeze one last one, more on the produce side. So I think Steve might have mentioned, the supply and demand dynamics in the tomato market and how it was a tailwind for pricing. Can you maybe provide some detail on what you're seeing in the market currently? And then when you might expect supply to catch up to where demand is?
Speaker 1
Yeah. Well, like I've always said with the produce challenges, the produce challenges are caused by the NAFTA agreement that change the dynamics, and it would be similar that if the Canadian government opens up importation of cannabis from South America as an example, it's gonna change the dynamic. And that's what happened in the produce industry. We compete with Mexico, and I've said and we grow in Mexico. You know?
It came to the point where we can't beat them, join them because it's a labor intensive industry, and we're paying $20 an hour all in whether it's our Canadian or US assets. And that includes, of course, benefits and all. And Mexico is still more or less at $6 per day per day for agriculture wage. So, you know, so I think with the pandemic, what's happened is, obviously, people aren't eating out. As I said in my remarks, 90 plus percent of our sales are to retail food chains, not food service, which has taken a huge hit due to nobody eating out.
So we were fortunate there. And people are eating at home more. It's driving greater fresh food sales. I think we're actually seeing, an inch much more of a stronger interest in US product as well with some of our customers. So I think that's driving it, and I think it's we feel it's pretty sustainable.
I think there's gonna be a lot of changes in the behavior of how people operate. People are getting comfortable eating at home. So we feel good about that. And, you know, we continue to work on our relationships. Part of the result was replacing volume that we lost in conversion of our greenhouses.
And so I think we'll continue on. I think I hope that answers your question.
Speaker 6
Yes. No, it certainly does. Thanks. That's it for me.
Speaker 0
Eric DeLorean with Craig Hallum, your line is open.
Speaker 7
Okay, great. Thanks for taking my questions guys. So I want to focus on the wholesale market. It's good to hear, at least on the retail side, that you think this price level is sort of the bottom here. You mentioned you've seen a bit of a revival in the wholesale market.
Would love to just hear your commentary on if you think this is sustainable or should we still think about these as sort of opportunistic lumpy sales?
Speaker 1
Yes, it's a good question. I mean it's hard to predict longer term. If we looked a year ago where we were in wholesale, not just in terms of volume in the second quarter of last year, but in pricing, that's dropped off a third of what it was. So that was probably non predictable a year ago. So to sit here now and say what it would look like long term, it's unknown.
I mean part of our wholesale conduit is extractors. We have good relationships with those folks, and, hopefully, that continues on. But I think at some point, you know, other we're working with other LPs. And let's face it, in our produce business, we've worked with competitors for years. We have good relationships with competitors.
We supply competitors. And to a degree, you know, I think that will get some, traction going forward. So I don't necessarily see it growing exponentially, but I think it's going to come back from where it was in the fourth quarter that was pretty nonexistent.
Speaker 7
Okay. That's good color. And then last one from me. I just wanted to touch on the two point o products. We've seen kind of some hit and miss results in the market.
Base is going be doing better than oils or softgels, for example. Just kind of wondering, what your guys' takeaway has been seeing competitors, in the market? And then if you can, you know, what kind of product mix do you think is reasonable going forward? Should we think of it sort of as like 75 flower for you guys and twenty five percent two point zero products? Or is that kind of off the market?
Just any color would be helpful.
Speaker 1
Yes. I mean, flower rules. And if you look even in The U. S, I mean, the major markets, California and Colorado, I mean, flower still rules. And I think it will for a long, long time.
I think the management team, the leadership, Mendesh, he has a real clear understanding of seeing what's working with others before we jump in. And so he's taken a very prudent approach to what products we're going to launch on two point zero and vape pens as an example, yes, is one, and see how that goes. And as I said in my remarks, once we enter a particular segment, we want to work it as best we can, make sure our price point is right, we can make money doing it and try to take a commanding lead. And I think, you know, that's on the horizon and, that and oil and probably not much more in the foreseeable short term till we make sure we can deliver those benefits and excel there. But I think, you know, when you look at the other markets, confectionery and beverage, they're still very, you know, very small markets, and, they still have to be proven out, see what the consumer preferences are going forward.
So we're gonna be prudent before we jump into those. But as I said, flower and, we, you know, we still have a ways to go in trying to dominate and build our market share there, and and we're very focused on that priority.
Speaker 0
Raul Sourgasser with Raymond James. Your line is open.
Speaker 8
Good morning, Mike and Steve. Thanks so much for taking my questions and congrats again you know, your your EBITDA streak and stuff that you've amended. So I guess my first question is a bit more of a macro question. You know, we're sort of we're seeing the market, you know, as a whole growing and in terms of dollar amount. But that said, of course, now we're also seeing, you know, incumbents, including yourselves, you know, with relatively flat revenue quarter to quarter.
So, you know, are you able to sort of comment on this dynamic? What do you think is driving it? And and do you think that it's something that will adjust over time as the market matures?
Speaker 1
I definitely think it will. I mean, the second quarter was a crazy quarter. I mean, you know, it's almost like we're forgetting the impact of the pandemic in in the consumers' minds in March and April. That was just, you know, sixty days ago, ninety days ago. So if you remember when we reported and and the other LPs reported, it was a very unstable time.
It was hard to predict. We weren't sure if the infrastructure rollouts by the provinces like Ontario would slow. People were staying at home. So it's really hard to look at what's happened there. So I think when we're already into the third quarter, and I could tell you in the third quarter, we're seeing much more stabilization and we're seeing growth.
So I don't think the second quarter is probably indicative of where the market is going. And that's why I'm really pleased with it because we went through that and we got through it in a very strong way. And I think we've actually said that we see growth in the third and fourth quarter continuing, not just because of the launch of our new products and new strains, increasing market share and further penetrating and cannibalizing illicit trade. Yeah.
Speaker 8
Great. That's On
Speaker 1
a macro level, I think, you know, I feel very optimistic about it.
Speaker 8
Right. That's really helpful. And then just one follow-up question. You know, you've got to fight Quebec as, you know, as the next Vanguard, province to penetrate. We recognize that HEXO has a, you know, quote, unquote preferred supplier position in the market whether, you know, artificial or not.
You know, how do you plan on dealing with that particular dynamic in Quebec as you penetrate?
Speaker 1
Well, that's classified. I mean, let's just see what the results are going forward, Raul.
Speaker 8
Okay. Great. And then just very quickly, you know, I'll just squeeze in a quick question about, you know, international. So, obviously, there is the Dutch can grow and then, the the deal in Asia. You know, how do you strategy rolling out and and committing capital to this sort of outsized long term opportunity?
Speaker 1
Yeah. Well, that's the key is long term. I mean, you could break these segments out. People can say, well, the CBD market, we thought we would have a lot greater traction today from December '18 upon decriminalization. But, of course, the monkey wrench of the FDA thrown in there, and we said we're taking a prudent approach.
But we're very committed, and we see that as a huge, very exciting market that we definitely wanna be a major force in, whether we build it, buy it, or work with partners in that market. But we wanna stay a little bit on the sidelines so there's clarity from the FDA. We just think it's prudent right now. So that said, there's you know, we've always said if and when on legalization of high THC or decolonization of cannabis in The US. Obviously, many folks are talking about it.
Even the tax opportunities for the governments and local municipalities are resonating, elections coming up. So it's anybody's guess what happens. But the opportunity is massive, and comparing it to Canada, it's just so massive. And, you know, we're ready to go. And, you know, I I would be honest with you that every day that I I don't really focus too much on the Canadian market because Pure Sunfarms is doing their job and and penetrating and doing well.
But I look at The US opportunities, and I wonder, you know, how long before anyone not in that marketplace will not have the same opportunities as those who can compete in The US market where we can today. However, that being said, having such a large footprint in what we consider the best growing region or one of the best growing regions, you know, Texas, where we are in Southwest Texas is probably the equivalent of what BC is to Canada in terms of growing conditions. So we have that footprint, and we can we can pivot instantly. And maybe we'll go that alone. Maybe we'll do it in partnership with others down the road, but that's a mass opportunity.
But in the meantime, we're just not gonna rest on our laurels. So we're looking at opportunities internationally. And I'll tell you about the Dutch Can Grow. What's so exciting about that is it just shows a movement of a specific European nation that has been very, very myopic on legalization of cannabis for decades, starting to show the trends of loosening up on the old mentality that cannabis cannot be legalized. And that's exciting for us because that's one of many countries in the EU.
That's why we're excited to be there. But these opportunities, you know, are also very long term. You know, we're not looking at adding positive cash flow in the short term. But so the decisions we make today are a combination of what we think can be a short term benefit, medium term, and long term. We wanna be at all three levels because the opportunity is massive over the next decade.
And, you know, we're pursuing pursuing that.
Speaker 8
Great. Thanks very much for taking my questions. That's all for me today.
Speaker 2
Thank you.
Speaker 0
Doug Cooper with Beacon Securities. Your line is open.
Speaker 9
Hi. Good morning, guys. Just on the value pack, you said it was 80%. I think, Steve, you said it was 80% of revenue in the quarter. How big do you think the category can be in total
Speaker 3
percentage of the market?
Speaker 2
A large format?
Speaker 3
Yeah. Yeah.
Speaker 2
I I I think under the current I mean, again, like we saw in tomato business, we've seen that we've seen a a movement towards the the lower priced products. So I I think for the foreseeable future, you know, the large format for dry flower will be the predominant SKU in the marketplace.
Speaker 1
Yes. If we even look at our numbers like March, when we just started to launch it, that small format was greater than 50%, and we were at about 40% on large that jumped to 60% in April, 76% in May, 86% in June. So in the second quarter, it really went from almost nonexistent in the first quarter to 78% as compared and small being 20. So I think that can give you an indication that when we launch new SKUs, it may change, but I I think a seventy thirty, sixty forty, eighty twenty is, clearly possible.
Speaker 9
So the so the the large, value pack priced at, I think, when you break it down, 50 a gram for retailer, for the for a retail price. Price point seems to be great for the consumer. Would you put that same price point in a smaller package? Is that part of the SKU you're coming out with?
Speaker 1
Not necessarily. You know, I think we have to be attractive there as well, but maybe not to the extent of the large format.
Speaker 2
Yeah. Your packaging cost and all that handling cost on the smaller format, it's substantially higher than it is on a large format.
Speaker 1
So you you actually I mean,
Speaker 2
you can't do that in the same value that you can in a large format. That's the beauty of the large format to the consumer. Right?
Speaker 1
Yeah. So when you really look at where we are, would be maybe because of the a number of reasons, but in June at 86% large format versus small, that really drove the margin down, but still north of 30%, which I think is pretty incredible. So as we introduce more products and our volume goes up, even if the large format remains a very large percentage with increasing sales, we feel very confident our gross margins will increase even if we maintain that low margin lower aggressive pricing rather on the large format. And speaking of growth
Speaker 2
for that, Doug Doug, was going to retail at in DC at the black market price of $99 per ounce. That's that was the focus of the Pure Sunfarms management team. They wanted to go to market at the black market price.
Speaker 9
You touched on that gross margin, you think potentially can move higher, as you progress throughout the year and into next year. Steve, can you just talk to us about the accounting, for two point zero products considering, I think you've said in the past that $01 TRIM is garbage from an accounting perspective. So what would be the how does the accounting work on that product line?
Speaker 2
Well, for us, again, as I said, the cost program is a nonindustry standard. So I know you and others are trying to track that metric. And I asked the question, well, does that include TRIM or not in the denominator of production? We do not. Pearson Farms does not include Trim, because ultimately, we're we're in the business of growing flour, and using the flour, but Trim is, used and utilized in cannabis two point o product being vape pens, etcetera.
Obviously, the cannabinoid content of TRiM is the same as it is with, number one flower. So for Pure Sunfarms, I can't speak to anyone else. For Pure Sunfarms, cannabis two point o, will will, be helpful in our gross margin because we value the trim at zero on on our accounting books. So that'll that'll improve the margin of cannabis two point o. So that input, the percentage of trim in the cannabis two point o product is zero cost.
Speaker 1
Yeah. And and also, Doug, I wanna add to something. I have some numbers, you know, just looking at where we're headed in, sort of July is, where the large format was 80% of the volume in q two, it sort of dropped to 60% in July and even down to forty five fifty, initially in August. So, you know, it's gonna be interesting to see if a big driver of that was also tied to the pandemic as well. And we'll get some more color on that over the next quarter or two to see how it averages out.
So I think it's still it's still too early to say specifically what that split will be.
Speaker 9
Okay. And then just two more quick ones for me. The $12,900,000
Speaker 5
of net sales in the quarter, how
Speaker 9
much was that on was Ontario?
Speaker 2
We don't. We we one, I don't have that information. Two, I wouldn't give it to you if I have it anyway.
Speaker 9
And CapEx requirements for the second half, given you're pulling back, I guess, on D3. Maybe just give an update where you are on D2. Obviously, that's you're not planning there. So what's the CapEx?
Speaker 1
No, there's no real CapEx requirements for the rest of this year. Delta two has had most of the investment in there. It may only need a few million dollars to kick it off. And we're starting to look at longer term projections of capacity requirements into the third quarter next year where we feel we may start turning Delta two on as well. But we're going to produce what we can sell and maintain our inventories levels at the level we want.
You've seen a lot of companies, I think, just producing, producing, producing, can't sell for whatever reason, taking write downs, and we're just going to manage that process. But as far as CapEx goes, we're in good shape.
Speaker 9
And sorry, my final one, just to you just mentioned it, so I'll just ask the question. We've seen a lot of inventory write downs at other LPs. Pure Sunfarms inventory stood at USD 36,000,000 at the end of the quarter. Any comments or comfort around that inventory level?
Speaker 2
We're, you know, we're we're comfortable with the inventory level. Obviously, you know, we tested for recoverability. So, you know, we've gone through that exercise. So very, very confident with the inventory that we have. This is a consumer good industry at the end of the day.
So as as new SKUs launch, it is it could impact in the future down the road on our inventory valuation. That said, the beauty of of cannabis is you can you can extract. So if if you have a strain that hasn't been successful or is negatively impacted by a new strain that we've launched and and the reason large format is down to some extent July and August, as a percentage of of Pure Sunfarms sales is because they have launched new strains. So that's the beauty of that, and they've taken a strain back in Ontario that didn't perform as well and was negatively impacted by the strong performance of other SKUs, if you can take it back and extract it and use the cannabinoid content in cannabis two point o. So, getting to Mike's point, managing your production and and manage for what you can sell and use and utilize in the near term is the way to avoid inventory write offs.
Download?
Speaker 1
Yeah. And we also feel, like, comfortable going forward with an inventory level of about 15 to 20 tons. Because as we roll out new products, we have that. So to just on Steve's point, we're comfortable where we're at for sure.
Speaker 3
Okay, great. And that's why we mentioned
Speaker 1
in the call, by the way, we did curtail some of our production at the beginning of the summer, just to be able to catch up. And, and that's just managing the process. That has nothing to do with COVID or or the pandemic. That's just managing the expectations.
Speaker 9
Perfect. Thanks, guys.
Speaker 0
Our final question comes from the line of Scott Fortune with Roth Capital Partners. Your line is open.
Speaker 3
Hey, guys. This is Nick stepping in for Scott. Most of my questions have already been answered, but I just wanted some color on the CBD branding side of things longer term. How are you guys thinking about building your CBD brand globally in The U. S.
Ahead of any sort of FDA movement? You mentioned being on hold here, but any color in terms of brand strategy would be helpful. Thanks.
Speaker 1
Yes. I mean, it's we just don't want to take any risks there, but have a program. We're looking at products that are not being scrutinized by the FDA and deciding if we wanna develop. We're still sitting on very viable high quality biomass. And we're looking at other opportunities with other other companies.
So I think, you know, I can't say, Scott, at this point, we're gonna move forth because we just wanna be clear what what the FDA guidelines are gonna be. And we felt a little more confident in recent weeks. Hopefully, after the election, things get focused on it. And so really looking at 2021 to, sort of, get back on course.
Speaker 3
Great. That's it for me. Thanks, guys.
Speaker 1
Thanks, Nick. Okay. I just want to thank everybody for joining us today. I hope we provided clarity. I personally am very, very excited about where we stand today and what we've demonstrated.
Now I I we're clear that our foundation for our business model is solid and we can build upon that going forward and then start to look at other opportunities both domestically and internationally. So we're excited. We look forward to reporting in the next quarter and we want to thank everyone for participating today and look forward to speaking to you again.
Speaker 0
This concludes the Village Farm International's second quarter twenty twenty financial results call. Thank you for your participation. You may now disconnect.