Village Farms International - Earnings Call - Q3 2020

Transcript

Speaker 0

Good morning, ladies and gentlemen. Welcome to Village Farms International's Third Quarter twenty twenty Financial Results Conference Call. Earlier this morning, Village Farms issued a news release reporting its financial results for the third quarter ended 09/30/2020. That news release, along with the company's financial statements, are available on the company's website at villagefarms.com under the Investor setting. 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 the call.

Details of how to access the replays are available in today'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 the 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 09/30/2020, 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 would now like to turn the call over to Michael DiGiglio, Chief Executive Officer of Village Farms International. Please go ahead, sir.

Speaker 1

Thank you, Carol, and thank you everyone for joining us today. With me on today's call is Village Farms' Chief Financial Officer, Stefan Raffini. This morning, I'm going to spend a few minutes highlighting the key takeaways for the quarter. Steve will then review the financial results and I'll return with some concluding thoughts and then we'll have some Q and A. The first highlight that I'd like to call out is profitability.

Village Farms once again achieved positive EBITDA with contributions from each of our business segments, cannabis and produce. Produce showed another strong improvement year on year and grew quarter on quarter as well. And Pure Sunfarms posted its eighth consecutive quarter of positive adjusted EBITDA and more importantly its seventh consecutive quarter of net income. That is an achievement that is unmatched by any other Canadian counter player. Pure Sunfarms quarter on quarter growth was driven by increases across all key metrics.

From my seat, this is hard earned profitability that demonstrates the underlying strength of our business model coupled with execution expertise which draws on both Pure Sunfarms cannabis market experience and Village Farms thirty plus years of experience in large scale, low cost intensive agriculture. As we welcome back this expertise under one roof with the closing of the Pure Sunfarms act, We look forward to even more opportunities ahead. On our last conference call, I shared with you that Q2 was a profound quarter for Pure Sunfarms, proving out that even with a very high proportion of sales derived from our large format, lower price offerings, Pure Sunfarms could be profitable. The third quarter now is evidence of the earnings power of Pure Sunfarms as sales grow. And as Steve will discuss, the composition of those sales in Q3 swung back to larger proportion of small format product sales.

An example would be our 3.5 gram offerings as a centerpiece, which currently drives our brand awareness, our BC grown branded house strategy. The second highlight I'd like to discuss is related to profitability in that it is a key driver of our success in amassing a leading share of the branded retail mark and growing our wholesale channel sales, and that is quality and cost of production. It's a by curious circle built and operates the most efficient operations to produce quality cannabis products to grow market share and drive profitability. The more brand strength we build, the more of our market's profit pool we should be able to claim. On these calls, we shared with you market share data that is available, and we hope that you will continue to benchmark our sales.

As we have only been in the retail cannabis space for one year, I am pleased that the sequential sales growth was a combination of underlying market growth, new product launches, brand performance and a more normalized sales mix. In Ontario, which provides a market share data that we all are able to discuss, the Pure Sunfarms brand again led all individual brands in terms of both volume, sales and dollar sales in the dried flower category with just under 13% share by volume. That number jumped in excess of 15% in October. We also remained the top selling brand by both volume and dollars, not just for the year to date, but going all the way back to the launch of our retail products one year ago. It's a remarkable consistent performance unmatched.

As you know, from the beginning, we have believed in a rather simple and straightforward business model, firmly rooted in our scale and efficiency. Our cost of production is still the lowest among publicly traded greenhouse and indoor producers and significantly lower than the vast majority of our peers. This is the key to our honest circle of generating profitability and brand investment. And here is how this standard this is translated into our Q3 cannabis results. Net sales increased 75 sequentially from the second quarter to just under $23,000,000 driven by strong increases in both retail branded sales and sales in the wholesale channel.

And I will note that only a small percentage, less than 5% of Q3 revenue was generated by the launch of our two point zero products, which was very late in the quarter. That drove a sequential quarterly increase in net income of 200% to 3,200,000.0 The third big takeaway from the quarter is that the value of managing our business with prudence and discipline. From day one, we have built and guided Pure Sunfarms for profitability and return on invested capital. We have done this with the advantage of our decades of experience. We did not overbuild as many others have.

And as I will discuss more in a moment, we are actively managing our production levels to the ramp in market demand. We continue to see increased activity in our wholesale channel, not the result of any shortage of supply in the market, but rather a strategic decision by some producers who have realized they can source high quality product perhaps at a lower cost than they can grow it. We are encouraged by this activity as it could mean better supply demand dynamics going forward. We believe this cost quality advantage combined with our long term capacity will be a significant competitive advantage for the foreseeable future. And we will continue to believe that we could supply as much as 30 to 35% of the total Canadian cannabis flower market with BC grown product in addition to being a leading brand with in excess of 20% of the retail channel.

I do I do want to remind everyone that with the acquisition of the entirety of Pure Sunfarms, our Village Farms is now free to use our 2,600,000 square foot Delta One facility for cannabis production anytime we deem that it makes sense to proceed. As a reminder, Delta one is located on the same site as Delta two and three, which provides significant advantages over geographically dispersed operations, is highly scalable and is about 20% larger than the Delta two and three facilities combined. We are now back at full production at Delta three after scaling back during the summer as we actively aligned our output and inventory with near term demand, which afforded us the additional benefit of doing a complete cleaning and sterilization. In addition, half of the 1,100,000 square foot system facility to Delta three, Delta two is completed. No other capital requirements with and to bring that into production in next year.

The most important operational highlight of Pure Sunfarms during Q3 was the launch of our first two point zero products and bottled oils in very late September. As we expected, the value proposition for our dried flower products that has resonated so well with consumers, high quality products that people want at an approachable price is similarly resonating with consumers of our vapes and oils. These products embody our uncomprising approach to quality and our commitment to a pure cannabis experience. Our full spectrum five ten vapes are made with 100% pure act cannabis extract, no flavoring agents, added terpenes, or thinning agents, and of our best strains. Both our vape and oil products have had excellent traction out of the gate and have been very well received by consumers.

Consistent with the pricing strategy for our dried flower products, we launched our oil and vape products at a price and quality that we believe will entice those still purchasing cannabis from illicit sources to transition to the legal market. As a reminder, the illicit market is estimated to still represent anywhere from around half to three quarters of the total annual cannabis sales depending on market and geography. These continue to be the power users of cannabis and will be a major driver of growth in the legal market. We believe that these consumers ultimately want to purchase their cannabis from a legal source and are happy to pay a fair tax in the process to do so with confidence in the consistency, quality, and safety of the product at the right price. Increasingly, they will have access to such product as legal cannabis resale network stores network rapidly expands.

And, again, we are uniquely able to take this market approach and be profitable. And I would like to once again publicly congratulate the entire Pure Sunfarms team, Mandish and his whole group on their successful launch of our two point zero products and yet another accomplishment by this remarkable. Our Q3 only further underscores the value and importance of our completion of the acquisition of the remainder of Pure Sunfarms last week. It brings our vision to take the unmatched assets, people, and know how of Village Farms to build the best cannabis business in Canada full circle. So turning to our cannabis opportunities in The US.

With the election behind us, we look forward to the regulatory clarity that may occur. We continue to be encouraged by the direction of the regulatory environment and have been hard at work developing multiple parallel strategies to expand a number of potential paths to capitalize on this opportunity. Internationally, we have invested in strategic partnerships like in Asia Pacific company Altum, which is making steady progress on the execution of its strategy, initially focused on the Hong Kong market. Turning now to our produce business for a moment. As I noted in the onset, Village Farms has had another good quarter.

The continuing strong price performance for tomatoes drove higher sales and our continued progress in transitioning growing capacity displaced for cannabis to our partner growers as well as our continued focus on cost management contributed to a $4,200,000 EBITDA turnaround to a positive $2,200,000 While these numbers are important in and of themselves, as you have heard me say many times, what is also critical important is the breadth and depth of the strength of the organization that lies our produce business. It is the engine that is powering our outsized growth opportunities in cannabis and related opportunities, both domestically and internationally. I'd like to turn the call over to Steve, and he'll talk through our financial results. Steve?

Speaker 2

Thanks, Mike. I'd like to expand on Mike's comments by providing more background on the financial results, which support the Village Farms strategy. Our produce business. Produce sales of $43,000,000 for the quarter increased over 12% versus Q3 twenty nineteen on the back of our average selling price of tomatoes increasing 30% year on year on lower tomato volumes as we had no production from our Delta 2 facility in 2020 as is now being converted to cannabis production, as Mike mentioned. The increase in produce selling prices essentially rolls directly into our gross margin as there is no impact on our cost of sales.

As such, we saw a year on year improvement in our Q3 gross margin of $6,200,000 to $5,600,000 from a loss in the prior 2019 of $600,000 Our produce business had a 13% gross margin for the quarter. The incremental increase in our gross margin was driven by the higher selling price and lower tomato volumes, again due to the conversion of the Delta two facility. Produce EBITDA increased by $4,200,000 year on year to $2,200,000 on the back of the improvement in our produce gross margin, which was offset by a lower year on year add back to depreciation since the Duffs II facility was not in production and a higher year on year SG and A in Q3 twenty twenty versus Q3 twenty nineteen of 1,200,000.0 which was primarily related to substantive expenses involved with the acquisition of the financing of the remaining Pure Sunfarms shares. I should note that these incremental SG and A expenses are not truly related to the produce business but are more corporate in nature. Supply shortages due to the increase in grocery store traffic certainly helped the produce pricing in the late spring and throughout the 2020.

I'd like to extend our sincere thanks to all the Village Farms employees who have continued to work all out in growing, distributing and supporting our Village Farms produce brands by getting our fresh produce on the shelves, our strategic retail partners in both The US and Canada. The commitment by our entire workforce has truly been amazing throughout the pandemic. I mentioned last quarter that the strong year on year pricing would result in positive EBITDA and cash flow in the produce business, and we expect this trend to continue for the balance of 2020. Turning to cannabis. A reminder, for the quarter ended 09/30/2020, the Pure Sunfarms results have not been consolidated in the Goat Farms q three results, as we owned 58.7% of the Pure Sunfarms business during the quarter.

But we did not control it until November 2, at which time we owned a 100%. I will address the consolidation of pro form a financials shortly. As Mike noted, sales for the quarter grew 75% sequentially, and we continue to build on our strong brand position, which I view as a strong indicator for our future, especially given the uneven year ago dynamics in the Canadian cannabis market. Pure Sunfarms retail flower sales represented 48.5% of our sales dollars for the quarter. The late quarter launch of Pure Sunfarms two point o products contributed 4.5 of sales four five 4.5% of sales this quarter, and wholesale sales made up the balance of 447% of our sales.

With the retail channel totaling 53% of sales, Pure Sunfarms quarter on quarter growth in retail sales of 30% was driven by a 166% 166% increase in its small format SKUs and a 30% increase in pre rolls, which were offset by a 43% decrease in Pure Sunfarms retail large format sales. The large format sales in this quarter were as expected ongoing replenishment sales as compared to the second quarter, which were driven by higher launch related sales. Our quarter on quarter average selling price did result in a 13.3% increase, which was driven by the increase in the ratio of our small format sales versus our large format sales, which enhances our margins as well as an increase in the blended net wholesale pricing for the third quarter versus the second quarter, but wholesale pricing was driven by spot market dynamics. We mentioned sequential sales growth. Looking ahead to Q4, while we continue to experience continuing month on month, year on year growth in our retail and wholesale businesses, I want to remind investors that Q4 twenty nineteen was marked by the pullback of retail buying by provincial buyers who are managing the conversion to Cannabis two point zero and their year end inventory.

To date, we have not seen any indication of this reoccurring, but Pure Sunfarms and our competitors still operate in a relatively new distribution system, and there remain many external economic factors, not to mention the pandemic, that could slow our strong momentum. In recognition of the overall supply situation in the market and our customer demand, we actively pared back our production during the third quarter, resulting in a decrease in our inventory both by volume and value. Overall, Pure Sunfarms inventory balance, including work in process, decreased approximately 6% quarter on quarter, which for those that read our financial footnotes can be seen on the footnote seven. Inside of the overall inventory total, we decreased our finished goods flower inventory by over 15% quarter on quarter. We continue to actively assess supply versus our demand.

Presently, the DUF three facility is back in full production based on our sales forecast. The ability to ramp up and down our supply is one of the beauties of this crop versus our historical fresh produce crops, which are annual commitments. We actively changed strains to mirror our sales forecast in order to maximize our cash flows, but more importantly, to maintain fresh flower inventory. Switching to Pure Sunfarms profitability. Gross margin for the quarter was 34.6% versus 33.4% in q two versus 68.6% in 2019, which had a totally different demand dynamic.

This quarter's cost of sales includes an inventory write down of CAD $1,400,000.01000000 US for the distillate inventory purchased earlier for which the market value has dropped since our purchase. Without the write down, Pure Sunfarms adjusted gross margin was 40.7%, which is a true reflection of the actual gross margin achieved against this quarter's. The remaining distillate inventory has been assessed versus the market value, and there's no need for any further distillate write down. The distillate will be used in cannabis two point o products in q four and early twenty twenty one. The receipt finally of the Pure Sunfarms extraction license from Health Canada in September will enhance our gross margin in cannabis two point o products.

The vape pens and oils in the market today were manufactured by a third party extractor. As such, the margin on these SKUs was lower than on our flower products in the third quarter. We expect our cannabis two point zero products to have a higher margin as we manufacture our own vape pens and other cannabis two point zero products in the coming quarters. It was important for Pearson Farms to launch these vapes and oil in advance of obtaining its distraction license due to the ongoing success of its flower brand. From a gross margin perspective on retail versus wholesale, the margins were somewhat similar this quarter.

Our retail margin was pretty consistent by format. So as we sell more small format SKUs versus large format, our margin is enhanced as occurred this quarter. As mentioned, we do expect an increase in our retail margin as we increase our Cannabis two point zero product sales and transition to our own manufactured two point zero products. Wholesale margins are driven, as mentioned, by spot market dynamics, which are heavily impacted by available quality and potency versus the needs of other LPs. We continue to actively assess our mix of sales by channel.

SG and A expenses for the quarter for Pure Sunfarms decreased approximately 13% year over year, which is a result of COVID-nineteen related wage subsidies. Without these subsidies, SG and A expenses were essentially flat year on year. As Mike previewed during last quarter's call, we have made the decision not to provide detailed information on Pure Sunfarms' total sold or produced or provide our average selling price or cost of production. As the market continues to become more sophisticated, it's not in our best interest to disclose. As you can see from our Q3 gross margin percentage of 40.7% without the distillate inventory write down as compared to our Q2 gross margin of 33.4%, we continue our strong financial performance consistent with the virtuous circle that Mike spoke of earlier.

It is simply not in our commercial interest to be telling our customers our cost of production or margins. We have demonstrated our low cost production and brand quality. No need to give away proprietary information. The Village Farms and Pure Sunfarms balance sheets continue to be on solid grounds to support our ongoing businesses and internal growth objectives. Both entities have borrowing capacity on their existing bank loans.

As an aside, on 09/30/2020, for first time since my tenure with Village Farms, we had a net cash position of $22,000,000 course, we just paid $60,000,000 Canadian or $40,000,000 to complete the acquisition of Pure Sunfarms on November 2 as well as issued a CAD 19,900,000.0 note or USD 15,000,000 due on 05/02/2021, to complete the acquisition. So we're back into our normal net debt position as of today, but we are on firm financial ground with our ongoing positive cash flow from operations in both produce and cannabis. Speaking of, as I mentioned earlier, our pro form a. As we mentioned in our closing press release earlier this month, Pure Sunfarms will be fully consolidated in Village Farms results beginning on November 2. As such, our Q4 results and full year 2020 results will include roughly one month of JV accounting, I.

E, October in Q4 and ten months of JV accounting for the full year 2020 and two months of consolidated Pure Sunfarms results in Q4 twenty twenty and for the full year. Since the acquisition of the remainder of Pure Sunfarms is deemed to be a material acquisition for Village Farms, we are required to file pro form a combined financial statements for the enlarged entity, so combining Gold Farms and Pure Sunfarms as if the transaction occurred retroactively to 01/01/2020. The report is due within seventy five days of closing. For Canadians on the call, this report, you will know as a bar report, meaning business acquisition report. In the interest of giving the market a view of the income statement component of the pro form a report, we've provided it within our press release this morning.

As caveated in the press release, this is for informational purposes only and is based on preliminary estimates and accounting judgments. Based on the early indication pro form a for the nine months ended 09/30/2020, our statutory reported income of zero eight dollars per share will be $0.13 per share if the businesses had been combined for the entire year. And our twenty twenty year to date nine month adjusted EBITDA would increase to $12,500,000 from our reported year to date adjusted EBITDA of 7,900,000.0, which I I will note does include we do include inventory write offs in our adjusted EBITDA when we report it. We do not add it back. As such, while still subject to the completion of the report, we are confident when we state the acquisition was very accretive for Village Farms.

We are actively working on the fair market accounting of the transaction and look forward to completing and filing the required U. And Canadian reports as soon as possible and hopefully no later than early December. I want to recognize and thank all the accounting staff for all their efforts and incremental work this year in converting Village Farms and Pearsons Farms from IFRS to U. S. GAAP as well as now the acquisition consolidation of Pearson Farms into Village Farms.

With that, I'll turn it

Speaker 1

back over to Mike. Thanks, Steve. Going forward, the outlook for Village Farms, I believe, has never been so positive with strong momentum in the business and considerable opportunity still ahead. It was a very solid quarter, many accomplishments. The team has done a superb job.

And going forward, each quarter is marked by steady meaningful progress in our transformation to a vertically integrated agriculture based CPG business as we aggressively pursue high growth opportunities in emerging legal cannabis and related markets in The United States and targeted markets internationally. We are proving out the value of leveraging the expertise, the people, the institutional knowledge for new high growth, high value markets. Pure Sunfarms is built entirely on the foundation of Village Farms, our model, our facilities, our people, our experience, our know how, all of which set it up for success by allowing us to bring in the best management team in the industry, and those are the Pure Sunfarms folks who continue to perform brilliantly. Owning the entirety of Pure Sunfarms not only provides our company and our shareholders with the full contribution of its financial success, but as a sole owner, we are now in a position to work to capitalize on opportunities that were constrained by this particular joint venture. Venture.

We expect continued steady strong sales momentum based on a number of very clearly visible factors. Growth in the Canadian cannabis market, which should be accelerated by the swift opening of new retail stores, especially in Ontario and British Columbia, the ramp up of sales of Alvape's oil products and the introduction of new two point zero products and a natural shift in the market landscape to fewer suppliers. This momentum combined with our unmatched North American assets totaling over 10,500,000 square feet, more than half of which is in The United States and which no other cannabis company in The United States or Canada has, is why we continue to be so confident in our prospects for low and high THC cannabis markets in The U. S. And internationally.

We have the considerable benefit of being able to pursue these opportunities funded by our produce business, which again is performing quite well. All this continues to position our company to deliver growth and generate a return on invested capital that leads our industry and drives value creation for all our shareholders. So with that, we'll open up to any questions that Johannos may have.

Speaker 0

Carol? Thank you. Your first question this morning comes from Doug Cooper from Beacon Securities. Please go ahead.

Speaker 3

Good morning, everybody, and congratulations on a great quarter. Steve, just I want to start with clarification on revenue per gram. You said it was up 13.3% sequentially. Is that just on the retail side, or is that, an average pricing between retail and wholesale?

Speaker 2

Across all channels.

Speaker 1

Okay.

Speaker 2

And

Speaker 3

can you talk a little bit about the difference maybe between the retail pricing and the wholesale in terms of if you don't wanna give exact numbers, maybe just the quantum difference between the two that you're seeing?

Speaker 2

Again, wholesale pricing the range of wholesale pricing can is all over the place, you know, whether we're selling, for instance, trim or selling high potency, you know, grade one flower. So the range is is much broader. The retail pricing is it's been pretty consistent, you you know, quarter on quarter between q two and q three, large format, small format. But, essentially, our average price was enhanced, and our margin was enhanced in q three versus q two because we, as a percentage, we sold more small format in q three as a percentage of retail sales than we did in q two, which was predominantly, as we mentioned on that call, driven by large format.

Speaker 3

Can you give us some idea of the break on the retail side, the breakdown, by region, say Ontario, BC, Alberta? And then did you have much sort of load in in the Saskatchewan? I think that came live in the quarter, if I'm not mistaken.

Speaker 2

Well, Ontario clearly continues to be our largest customer. But and and and there are and also impacting pricing is that there are pricing differences on the format between the provincial buyers. So, it's it's not like a a national price. So it it does it does vary. So a weighting of sales into one quarter into one province versus another quarter also will impact the average selling price for a particular quarter.

Speaker 1

Yeah. I think going forward, Doug, the aggressive growth in retail stores that Ontario is talking about right now, very aggressive over the starting now over the next year coupled with, BC, I think that'll continue to drive, more penetration going forward in Ontario, seconded by BC.

Speaker 3

What you think the optimal split in your business is between retail and wholesale? And, Mike, can you just comment maybe a little further? Maybe I missed it. You talked about maybe the number of suppliers dropping. Can you just expand on that a little bit?

Speaker 1

Well, that's a perception, but I guess I'll on it by saying there are many examples of premium brands, CPG companies that are very well known brands, have huge penetration and market share, but have a wholesale strategy. There's a lot of examples of that. And it's still a very nascent industry, and and we want to keep our options open where we're going. You know, for us, we've made the investment already, the capital investment delta two, which can double the capacity right here with Village Farms. As I mentioned on my remarks, we have Delta one, which is larger than those two cumulatively.

So, you know, our our focus is as a branded house to continue to maximize our market share at the retail level. But, right now, I think a wholesale venue for us works. There's a lot of smaller companies that have a unique niche in the marketplace or are doing unique things that don't have cultivation. And to the extent that those companies are innovative and maybe doing things we won't do or can't do or may never do, why not have a relationship with that? And there are some companies you know, we in our thirty year history in produce, even though 80 75 to 80% of our sales are direct to the retail trade, we've always had relationships that make sense on portion of our business.

So I think I'd rather not say there's not really a goal what that percentage will be, Doug, but we'll see how it goes over the next two years. It should be a lot of interesting changes in the Canadian landscape.

Speaker 3

K. Do you have a do you know what the breakdown maybe just talk about Ontario in particular breakdown between sales is at the retail level between flower and two point o products? And I guess I'm just trying to you know, if two point o products were 4.5% of your sales, what do you think they could be, you know, six months, a year from now?

Speaker 1

You know, I we still believe flower rules. I mean, I I if you look at The US or individual states, it's still flower, and, there's no indication that that's changing. I think we'll see increased cannibalization of the illicit trade with two point o products taking more of it as as these stores roll out and there's a retail presence and the Canadian government maybe once there's adequate amount of retail stores will shut down more and more legal trades. But as far as the split, I think two point o products will continue to grow, but the greater percentage is still flour. You know, as I mentioned on the call, our 3.5 gram, premier strains are doing very well and we see that continuing to grow for the foreseeable future.

Speaker 0

Your next question comes from Rahul Saragasv from Raymond James. Please go ahead.

Speaker 4

Good morning, Mike and Steve. Congrats on the rocking quarter. Well done, guys. So first question is, clearly, there's a clear dominance in the Deep Value segment in flower. Now with the emergence of your putting out vapes on the market and noticing the pricing, I guess you guys are being pretty aggressive in pricing.

So how do you see pricing going forward driving revenue relative to the competition, particularly as retail is opening up as you noted there, Mike?

Speaker 1

Well, I'm just going to reiterate, Raul, that our pricing strategy was always based on the fact that we saw the illicit trade and the the main consumer in Canada being the consumer's been there for decades, the everyday user, the casual weekend user, and that's the target market we've gone after. And in order to provide in order to cannibalize that customer to us, we have to order all offer all these key attributes in terms of quality, potency, safety, so on, but at an affordable price. And that was coined by the team at Pure Sunfarms early on, affordable luxury, and that's a focus of it. So that's where we're positioning the price points, and we're doing that more or less with all the products we launch. Now if that price point is 30% under other competitors, so be it.

It's you just have to live with it because that's setting the market. It's a $56,000,000,000 listed trade market that needs to come here. So that's how we position the pricing going forward.

Speaker 4

Okay. Great. Thanks so much. And then in terms of the, the wholesale, clearly, was a, you know, relatively large portion of your total rev. So number one, do you see that, you know, being durable?

You know, are you seeing durability in that going forward? And also maybe provide your your comments in in the context of, you know, the recent crop to Croptober of outdoor grow and how do you see Village Farms product you know, competing particularly in the wholesale market relative to all of that outdoor grow?

Speaker 1

Well, you know, wholesale has a stigma attached to the term. So maybe, you know, the correct term is in wholesale as opposed to alternative channels. An example would be, I mean, private private brands. I mean, if if Costco in Canada wants to eventually sell cannabis under their corporate brand name, I mean, that's that's an alternative channel. So I think wholesale tends to have this stigma that it's, not important.

And, again, I think it's too early to tell, but we we'll look at those relationships that we think could be meaningful. We're profitable to use the term wholesale. We are profitable at the wholesale level. We proved that, all along. So, right now, when we look at the fact that we've made our investment in Delta two, but we weren't quick to, you know, put that in production.

We're very prudent with our decisions. We don't wanna produce anything that we can sell, and we're gonna be patient as we ramp that up. But, we can look at alternative channels and still remain true to our positive cash flow. So I look at it as a combination of wholesale, private brand, other markets, other channels that people are doing very innovative, niche oriented offerings and see how that flows in the next couple of years for us.

Speaker 0

Your next question comes from Adam Buckham from Scotiabank. Please go ahead.

Speaker 5

Good morning. Thanks for taking my question. Now I understand the Canadian rec market is both volatile and dynamic. But as we think about Q3 flower mix versus moving forward, you see this quarter as a more normal mix? Or do you think there could be further shifts in small format in the near term?

Speaker 1

I think, I would say, you know, a more normal certainly, a much more normal quarter than the second quarter. And certainly, for us, if you remember last year, Adam, I mean, we were we didn't have our sales licenses basically almost into the fourth quarter of last year, so it's been one year. So we can't really look at how we performed last year. As Steve said in his comments, it was a different market last year, and we were selling solely 100% wholesale from the first, second, third quarter. So for us, getting some historical data going forward is what we need.

The second quarter of this year, and to an extent, the third was really impacted by COVID, especially the second quarter. You've heard people other companies saying, you know, pantry hoarding and so on. And I think the fact that we launched a large format at that time It was the right product at the right time. But I think, this third quarter has shown where there's more normalization, between, our offerings.

And it's early for us on a two point o. We just launched it at the very end of last quarter. We're very pleased, where we are today. We didn't wanna talk about any specific numbers at this point, but I can tell you we remain very confident in the direction we're going from the early numbers we're seeing. So I think it's a great question and I think the fourth quarter will probably help reinforce what that balance will be.

Speaker 5

Okay. That's great. Thanks. And I was just wondering if there's any updates on progress on signing some new provincial customers.

Speaker 1

Well, is progress. I mean, we're still eyeballing Quebec. The team's doing a lot there. It's not an easy penetration, but we feel confident that slowly we'll make a non trie into that, and that's clearly at the top of the pinnacle right now is Quebec. But, you know, I think what's more interesting for us is finally the traction that, Ontario and British Columbia are showing in opening stores.

I mean, Ontario's talking about, you know, in the realm of forty, fifty 30 to fifty, thirty to 60 stores per month on the month. Looking at 500 stores by April, doubling that to a thousand by next September. That is very, very exciting for us. We've had conversations and on greater capacity, and I think British Columbia is moving in that through it not as aggressively. And I'm excited about it because we've always talked about the fact that it's like the end of prohibition in The US except that the government of the US did nothing to shut down the Kentucky moonshiner.

So at some point here when there's enough enough retail stores and a great channel for legal product, then we hope that there'll be some pressure on the illegal trade and that will continue to increase greater penetration and market share for us going forward.

Speaker 0

Your next question comes from Aaron Grey from Alliance Global Partners. Please go ahead.

Speaker 6

Hey, good morning guys. Congrats on the quarter and as well as the recent acquisition of Pure Sunfarms. First question for me, Mike, you just mentioned that you're pretty encouraged by the two point zero products thus far having just recently launched them in September. Just wondering if you could give any incremental color there. It's been another category where you're starting to see some pricing pressure even just looking at the OCS website.

They have specific dedicated kind of channels just for like under $5 or I'm sorry, 7. So just curious towards what you're seeing in terms of those dynamics and how you think, you know, Pure Sunfarms is being positioned, especially kinda leveraging the brand equity you guys have right now within the flower category. Thanks.

Speaker 1

Oh, I didn't realize the price was that attractive. I must have missed that. But, just kidding. Well, you know, we didn't put some I mean, Steve alluded to in his comments that, we launched early, and we were because we waited a long time, as you know, for our final extraction licenses. It's, we're in the extraction mode now.

So we weren't that concerned with the margin. We kinda knew what our margin could be at a given price, and we knew we were gonna go out probably somewhere in the realm of 30% under existing competitors, again, tied to the illicit trade and mimicking what we did on the flower side. So, you know, we think, for the most part, we were gonna allude to that we're a leading vape. Our brands are kinda leading today, but we didn't say that so much in a release. But we've seen some data where we're sort of in the top three so far, and that's very encouraging both on the quality of our offerings there.

So I think pricing wise, we think the margins are gonna come in very similar to our margins on flower right now once we get traction. And I think that'll that visibility will be there when we report the fourth quarter. So we're we think, yeah. There there is gonna be price compression, but that's something that we said from day one. So we're prepared for it, and our model is based on that.

Speaker 6

Okay. Great. Thanks for that color. And then secondly, obviously, Ontario has been a great province for you guys. It's done really well in terms of

Speaker 5

market share, but, you know, kind of acting a different way in

Speaker 6

terms of some some traction with other provinces, you know, specifically looking at, you know, Alberta, which is also a big province for Canadian cannabis. Can you talk about some of the traction that you've had there and maybe how it might be different considering what you're seeing in Ontario? Because obviously you've had great market shares in Ontario. So can talk about the trends and maybe the differences in terms of buying patterns for the provincial buyers or what you're of seeing in in Alberta and, when we might be able to see some more traction from some of those markets too because you've just been doing so well within Ontario? Thanks.

Speaker 1

Yeah. I think the reason we talk about Ontario is because we have the data. And we don't have the data in the other provincial government, so we don't feel we don't feel like we should talk about it because we'd be speculating somewhat where Ontario you know, we're very pleased that we get that data. So, I wouldn't wanna talk about it other than perception. And my perception from the Pure Sunfarms feedback is we're doing pretty well in Alberta and and BC, except that BC needs to really increase the amount of stores.

That really needs to happen. They've been pretty slow. It's still the number one consumption in Canada. So the good news is there's a lot a lot of growth there based on cannibalization of the illicit trade. And the second good news is that traction is starting to be recognized in BC, but it's gonna take time.

Like, for an example, even though we're doing well in in the province of Ontario, but if you look at I was just talking to with Mandish yesterday about it in, like, Mississauga, a suburb of Toronto that has a million people does not have one retail story yet. So that city council, I guess, has decided they're not ready. So that's a huge potential down the road when and if that happens. And so that's just an illustration of certain pockets that will take time to gear up on retail, and, we feel very encouraged about that. So that's the best color I can give on it right now.

Speaker 0

Your next question comes from Scott Fortune from Roth Capital Partners. Please go ahead.

Speaker 7

Good morning and thanks for taking the question. Can you provide just a little color on kind of the cadence of two point zero products and the velocity there at the provinces? It seems there's still, like you said, too many competitors in there, too many brands. Some are moving and not all are moving at the inventory level for these provinces, but just kind of your sense for the velocity of your two point zero products moving forward?

Speaker 1

Well, we were sold out pretty quickly on the launch. So we were actually you know, I was pleasantly surprised. So it it sold out pretty quickly. And, you know, the indications are we're gonna gain that we're gaining and will gain more traction, including at our price point coupled with the fact that it's pure cannabis. We're using our best strains, for the extraction.

This is top of the line. There's no byproducts or any of that, and we think that's gonna resonate well. We feel really good with our two point o line. It's just that, we don't have even a full quarter under our belt, and we wanna kinda just be a little more conservative till we can talk, specifics. So but it is to grow, you know, the two point o products we have too, and and we kept pretty myopic on where we were going with the products that have large market share.

You know, we're not really focused on confectionery or beverage right now. Maybe that'll come more in the future. Those markets still are relatively small to us. So, we wanna get our penetration higher as quick as we can. And, so far, so good.

So

Speaker 7

And then follow-up on that. How how many two point o SKUs do you do you have out there? And then kind of what's the sense for that, picking up or or trends of different products and SKUs as we look up to 2021?

Speaker 1

Well, I think there's about three, but we're launching another Vipron as we speak. And as I mentioned on the last call, we're ready to roll out edibles in the foreseeable future. So that'll probably put us initially at somewhere between five and seven. And, you know, that's the for us, that's a good start. It's a good start, good launch.

And, once we get feedback, we'll see consumer feedback. We'll see what else we plan to do.

Speaker 0

Your next question comes from Eric DeLore from Craig Hallum Capital Group. Please go ahead.

Speaker 8

All right. Congrats on a solid quarter, guys, and thanks for taking my questions. So you mentioned that you're at full production in Delta three and that Delta two could come online in 2021. Can you just help us understand what you need to see in the market before bringing Delta two online?

Speaker 1

Well, we need to see, you know, you know, what we've done, like, over the summer, we saw sort of things slowing down, and, we felt it would be prudent. You know, we always wanna produce what we can sell. In fact, without giving any numbers out, if you just look in the third quarter like in August, we curtailed our production during the summer. And if you remember, Delta three was converted and we started to we got into an originally wholesale production while we're still doing the conversion. So it was a great time for us to look at the market and say, better slow things down, move some of our inventory out.

And in fact, in the in August alone, in the third quarter, we sold more than double what we produced. So taking that prudent conservative approach on reducing our capacity over the summer proved out very well for us. Our inventory is right where we want it to be. The churn is solid. And, so now we're back into full production on Delta three.

It takes time, as you know, to ramp up. Now we've done the conversion and the capital has sunk into Delta two. It's just a matter of gearing it up. And, you know, our expertise is thirty years of gearing up. It's a it's a process.

You just don't get to excellence overnight. So we're gonna start gearing Delta two up to get our people up to speed, and we envision that we'll start looking at increased capacity probably third quarter and then prudently ramping that up based on our supply demand numbers. We're not in any rush to go to overcapacity. So we'll just be monitoring that every week as we go or every month, I should say. And then, you know, keep in mind the way our facilities are set up with 16 to 17 grow rooms, we have the capacity to bring on it in a slow ramp up as opposed to just banging it.

Speaker 8

Okay. That's helpful. I appreciate the color there. And then maybe maybe turning to The US. You know, since the election, there's been more talk of cannabis legalization in Texas.

One law firm projected Texas could produce billions of dollars in tax revenue. And just this week, we've seen 13 pieces of cannabis legislation filed in the state. Can you comment on your readiness to serve a potential Texas cannabis market and how your existing agriculture business, could position you for a successful license application?

Speaker 1

Well, I'm not except to say that we are working and have been working all out on multiple strategies. So, we're very excited about The US, but I don't wanna put anything out at this point, other to say that I think, you know, if you look at our playbook, our principles, the results, and our achievements of what we've done in Canada by the way, we were nowhere near first, second, or third in The Canada. And I now opinion today, we're leading in every major met metric from our number one brand to a low cost production, the most profitable, most consistently profitable. And those are results and achievements, I think, will go a long way to us entering The U. S.

Market. So we're looking at the regulatory process and we have multiple strategies. And I will say we're very excited about the possibilities in The U. S. For Village Farms.

Speaker 0

Your next question comes from Andrew Parthenon from Stifel GMP. Please go ahead.

Speaker 9

Thanks for taking my questions and congrats on the great quarter guys. You continue to set yourself apart from your peers.

Speaker 1

Thanks. Thank you.

Speaker 9

Just on the ordering dynamics from the provincial boards, could you give us a little bit of color on how that's going? We've already seen a little bit of shift from big initial bulk orders to smaller orders but more frequent. Would you say that that is still the case? And you called out your initial launch on two point zero products selling out quickly. How quickly did you feel that provincial boards reordered?

And are you satisfied with the inventories that you have at the retail level?

Speaker 2

Yes. Well, as I mentioned, I mean, this is a very new distribution system. Provincial buyers are, as as an earlier analyst mentioned, have a lot of excess of of certain SKUs or certain strains or vape pens that aren't moving. So there's a little bit of, guesswork, I guess, on on their part. You know, we've been very happy with with our sell through.

When you know, as Mike mentioned, we sold out of the vape pens, which on one hand, you say, well, you know, that's a a a testament to, you know, strong demand. The flip side of that is from a CPG standpoint, that's a lost sale. If if if the consumer goes in asking for Pure Sunfarms flower brand or for a vape pen and they're out of stock, then they're either buying something else or they're turning around and walking out of the store. So that's a lost sale for us. So, you know, as as Mike mentioned, you know, we're we're continuing to get get more data.

We're continuing to actively work with the provincial buyers. Again, a lot of of incremental sales has to do with, you know, actively working with the buyers to make sure that store shelves are stocked with our product, and, you know, putting time and effort and people and resources behind manager inventory at all levels, not just what we have on hand, but what's in week at the retail level and in the DCs is imperative to drive your long term success of your brand.

Speaker 1

Yeah. And I think also, you know, Pure Sunfarms team has told us that they all want to grow, very much so. So the collaboration is more positive than ever, and, the orders are becoming more consistent than they have been. So, as Steve said, and I think the team's noticed, they're getting better at their forecast. And, we see it exceeding you know, starting to exceed the orders we're placing.

So they're placing. So we think it's it's definitely in in a better way.

Speaker 9

Great. Thanks for that. It's very helpful. Switching gears to, you know, your your smaller product format and and how they that might tie into, you know, the new strains that you guys launched. Think strain innovation is probably a key thing that you guys have under your belt.

And, you know, anecdotally, I see on the front page of the OCS, you know, you guys are called out with your twenty eight grams of Pink Kush for $5 a gram. So can you give a little bit of color on what you guys are doing in terms of developing new strains, launching new strains, and how they that might have played a part in the good growth of the small product format in this quarter?

Speaker 1

Well, product you just mentioned was per personally earmarked to analysts living in Montreal that would come down over the weekend and, load up.

Speaker 2

Yeah. It's a constant innovation process. I mean, they're they're constantly, obviously, buyers, provincial buyers, consumers are always looking for something new and innovative. So it it's a constant process, and that's one of the reasons that the Delta Delta three facility and the Delta two facility were designed the way they are with multiple grow rooms. So we can constantly, try new strains, both in the marketplace, but also on a cultivation standpoint.

Speaker 1

Yeah. And there's a lot of strength in the pipeline. I mean, our connection to our brand that's one of the things about British Columbia. We're all renowned in cannabis production, and it's a huge difference. The that thread in the fiber of British Columbia cannabis is like no other in Canada.

You're just not gonna see that in Leamington. So that DNA, that history goes way back. So I can tell you there's a lot of strains in the pipeline, and the team there looks very, strategically as they launch them, how, when, where. And so I think you'll continue to see, as Steve said, a lot of innovation, coming forward with new strains. And everyone is excited about it.

I think that's one of the benefits of our location in sort of the heart of cannabis territory in Canada.

Speaker 0

Your next question comes from Doug Cooper from Beacon Securities. Please go ahead.

Speaker 3

Hi, guys. Everything's been answered. Thanks very much.

Speaker 1

It's just the other bag. Okay. We're good. I think we're good, operator.

Speaker 0

Thank you. Your next question comes from Rahul Saragasar from Raymond James. Please go ahead.

Speaker 4

Sorry, Mike. Just yes, one last question. So I know you said that you'd prefer to keep your U. S. Strategy to yourself, but maybe if you can just sort of elaborate more generally given the, you know, the recent, changes in The US at the at the federal level, how you see things playing out and and how those farms, you know, would be would be able to compete generally relative to the MSOs, which, are quite in favor at the moment?

Speaker 1

Yeah. I think, let me say this. I mean, the MSOs have done a great job. I think a lot of them, you know, they're pure play cannabis companies that have focused on bricks and mortar and distribution. But, you know, in time, we believe that interstate commerce will happen, and I think that's one area that's that's where we shine the best.

You just can't have five, seven, eight production facilities in a given state indoor, you know, five, six, seven growers or one grower going around if you're gonna really try to have incredible strains and consistency. So one example with MSOs is as as successful as they are, and they will be more successful, especially the national ones, big market cash, deep pockets, no doubt. But they're gonna have to find how they can be cost effective because in the end, like we've proven in Canada, things will get competitive. And even if in the end, there's a migration with technology less in flower to other deliverables, I think we could play our part. From a Texas perspective, if Texas, yeah, there's a lot of bills out there.

We don't know. You know, unfortunately, Texas meets every two years, so we have this one window between January and May, whether it's a medicinal play there, I think first rather than rec or nothing happens and it's two years out. Once we launch in Texas, we'll be sort of first in with assets ready to go. We've already have our conversion plans. We're ready to go in Texas, and that's the size, you know, population nearly as Canada.

And the way Texas is going, it'll probably be very close the next few years. So that in itself is like the Republic Of Texas or a country, but that doesn't mean we won't work nationally. And we're prepared to look at, you know, if we have to do acquisitions or, strategic partnerships in other locations, where we can bring our strengths to the table. I think there's a lot of opportunity there. We're pretty well known.

As you know, Village Farms is in principle US company. That's where we are. So it's like coming home, and, we're excited about, an array of possibilities for us.

Speaker 4

Great. That's all for me today. Cheers.

Speaker 1

Thank you. Okay. Thanks, Carol.

Speaker 0

This does conclude the Q and A portion of our call. And I'd like to turn it back for any closing remarks.

Speaker 1

Okay. Once again, thanks everyone for joining us today and we certainly look forward to speaking with you on our next call. That will be a very exciting one for the fourth quarter year end, full quarter of consolidation and updates on how well we feel we're doing. I can just tell you, I remain the largest and happy shareholder on this call today, and I'm very excited about our opportunities going forward. I thank you for your participation today.

Thanks, operator.

Speaker 0

Ladies and gentlemen, this does conclude today's conference call. Thank you once more for your participation. You may now disconnect.