Q4 2011 Village Farms International Inc Earnings Conference Call

Mar 15, 2012 AM EDT
Thomson Reuters StreetEvents Event Transcript
E D I T E D   V E R S I O N

VFF.TO - Village Farms International Inc
Q4 2011 Village Farms International Inc Earnings Conference Call
Mar 15, 2012 / 02:30PM GMT 

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Corporate Participants
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   *  Stephen Ruffini
      Village Farms International, Inc. - CFO
   *  Michael DeGiglio
      Village Farms International, Inc. - CEO

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Presentation
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Operator   [1]
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 Good morning. My name is Adam and I will be your conference operator today. At this time, I would like to welcome everyone to Village Farms International Announces 2011 Year-End and Fourth-Quarter Results Conference Call. (Operator Instructions).

 Stephen Ruffini, you may begin your conference.

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 Stephen Ruffini,  Village Farms International, Inc. - CFO   [2]
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 Thank you. Welcome, everyone. Before we get started, I need to read the following statement. At the outset of today's call, the Company notes that our discussion today may contain certain statements that include forward-looking information. Accordingly, we refer you to the Company's most recently filed MD&A, under the heading Forward-Looking Statements, which, amongst other things, identifies material factors that could cause actual results to differ materially from any forward-looking information. Moreover, any forward-looking information may be based upon certain material factors or assumptions. Please refer to the Company's most recently filed MD&A, under the heading Forward-Looking Statements, for further details.

 With that, I want to review our results. Our 2011 revenues increased CAD19.6 million to CAD164.4 million, which was a 14% increase year over year. The increase was primarily driven by a 27% increase in supply partner revenue, coupled with a 5.5% increase in Village Farms' greenhouse supply. While we experienced good pricing through most of the first nine months of 2011, during the fourth quarter we experienced a decrease of 18% in the average selling price of tomatoes versus fourth quarter 2010 average pricing, ending the full year with a 2011 average price which was 2% below our 2010 average price. Much of the pricing pressure is coming from increasing Mexican and Central American supplies. Our cost of sales increase of 14% was driven by the same drivers -- of our revenue increases -- increased mainly supply partner volumes, in which we earned a marketing commission, as well as increased Village Farms volumes.

 Our Texas volumes in the fourth quarter of 2011 were up against our 2010 volumes, due to not experiencing the white fly issue that we had in one of our Texas greenhouses in the fall of 2010. We did enhance our growing yields in most of our Village Farms greenhouses in 2011, which lowers our cost of production. But those lower growing costs were offset by increases in our packaging and shipping costs, due to increasing packaging costs as we expand our cucumber and tomato specialty lines, as well as increased transportation costs.

 Our SG&A increased by CAD1.4 million, or 11%, to CAD14.6 million in 2011 from CAD13.2 million in 2010. Much of the increase was driven by some of our key initiatives, which Mike will be talking about and which we talked about in our press release, such as the expansion into the Dominican Republic in new branding, as well as the overhead in costs involved with getting our new Monahans project underway.

 The change in our biological assets for the full year was, for the most part, unchanged, with an ending balance of CAD5.572 million versus the 2010 year-end balance of CAD5.223 million. The increase was driven by higher volumes in the early part of 2012 versus 2011. It should be noted that our new volumes for Monahans in 2012 did not impact on our year-end 2011 bio asset, as sales of Monahans produce did not commence until late February. The new volume increase coming from the Monahans will have a positive impact on our bio asset on March 31, 2012.

 Net income increased to nearly CAD1.6 million to CAD5.8 million from just under CAD4.3 million in 2010, due to higher production volumes, primarily from our supply partners, as well as higher year-on-year change in our bio asset, plus a gain on financial derivatives in 2011 versus 2010. Our earnings per share increase of 35% was in line with our net income increase, as there was only a marginal change in our fully diluted shares between 2011 and 2010.

 Our full-year 2011 EBITDA of CAD15.7 million increased 4% over our 2010 EBITDA, due to higher volumes. Our key 2011 initiatives did negatively impact our current-year EBITDA performance, even though the initiatives will generate future-year EBITDA for the Company. For instance, our DR operation negatively impacted our 2011 EBITDA by roughly CAD300,000 in 2011.

 The new Monahans structure greenhouse is operational and producing fruit. We did substantially complete the greenhouse by year end, which qualified us to expensive the entire greenhouse for US tax purposes in 2011. The pack house is not yet operational, but we are packing from our Monahans produce right now at our Fort Davis facility. And the pack house should be open and operational in the next couple of weeks. Construction project, without lights, is expected to cost a total of CAD42 million, which is about 8% over our original budget. The overruns were primarily in the areas of infrastructure and utility costs. But these costs will benefit future expansions at this site.

 We continue to maintain a strong balance sheet. Our net debt at December 31, 2011, was CAD67 million, which equates to a net debt to EBITDA leverage ratio of 4.3 times, which is in line with our expectation that we would be in excess of four times at year end. We have not fully borrowed on our Monahans term debt at year end. Our outstanding balance was just over CAD21 million against a total borrowing capacity of CAD28 million on that term loan. Since year end, we've made additional construction draws of roughly CAD3 million and expect to fully draw against the facility sometime in the second quarter of 2012, when we fully pay for the entire CAD42 million construction project.

 The Company generated cash flow from operations of CAD18.8 million in 2011, which was a CAD2.6 million increase over 2010. With our 2011 construction activities, we were very judicious in managing our balance sheet throughout the year and maintaining our cash flow focus through the early parts of 2012. As our new Monahans facility begins to generate operating cash flow in the second quarter, we will be very focused on lowering our leverage ratio, and expect to be under four times by year end.

 With that, I will turn it over to Mike DeGiglio, our CEO.

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [3]
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 Good morning. I will be brief, and then I'll open it up to Q&A. But for 2011, looking back on it, it was a pivotal year for the enterprise. We had a number of very aggressive initiatives with aggressive timelines. And those were completed as per the objective timelines. And I think a number of those will clearly set the Company for another level of growth and performance over the next few years. As we've -- Steve has mentioned, the Monahans initiatives -- that was a very aggressive timeline, especially with the technology change. It's the comparison to traditional technology to what I would consider almost bleeding-edge technology -- made it much more complicated to put the facility up. So, in the time that was allotted and we completed it internally, we felt very good about that. A lot of the technology was updated from the original R&D pilot test project of GATES in Marfa, which we had first built in '96, '97. So there were an array of improvements that were added to this.

 And, we began harvest -- as we reported -- on half of it. With the remaining half, first pick is actually scheduled for the end of next week and going forward. So, so far, things are on track. The DR was another big initiative. We really need to increase our diversity for our customers, and peppers is a key component of that. Clearly, we'd like to produce peppers ourselves in the US. But this was an important driver for us. And it was a first advance fulfillment center with state-of-the-art food safety guidelines in the facility incorporated. And we've commenced harvest and shipping last November. And, so I'm happy to report that's completed.

 Two years ago -- we have always had an innovation department within the Company that focuses on new varieties. But we've kicked that up, with adding some top talent two years ago and advancing our relationships across many seed companies, many international ones. And we have a pipeline of varieties that we continue to work on and test that will diversify our product selection, both in tomatoes, cucumbers, and peppers. Last year, as you know, we launched the Mini San Marzano. And that's on an exclusive arrangement, which -- that's what we're driving in the future, at least for a period of time before it becomes available to others in the industry. The initial feedback of the product has been very positive. And we are increasing that pretty substantially this year and into next year as part of our product mix.

 Last year we commenced producing cucumbers. That was driven by our customers -- both longs and minis -- and we're going to continue to expand that, as we mentioned in the press release, this year as well. In '09, traditionally the Company has been very strong with the retailers. At the end of '09, we focused on changing our customer mix somewhat, and concentrating on many of the large, big-box customers. And I'm happy to say, in that three years, we've now -- are supplying all of them. And we have increased our long-term contract sales to 20% from 0%, with a target of 50% going forward.

 Last year we also took an initiative, after 20 years, of rebranding Village Farms, both for the trade and for something that is -- could be identified and more friendly for consumers. It's not just a change in the brand design but, actually, the packaging. And as Steve mentioned, as we continue to diversify the product line in specialty products, both in the snacking category -- the way we package that for consumers is very important. And the feedback there has equally been positive.

 As far as the marketplace goes, half the marketplace is really in the food service industry as opposed to retail. It's an area that we haven't been active in. And we've started to push our expansion into food service last year, represented about 9% -- about 1% of our sales. And we think that that will be increasing pretty dramatically, going forward. It's being driven by the same thing that really drove greenhouse products years ago. And that is food safety, sustainability, and taste and quality. So, we're going to make a strong effort going forward and looking and testing varieties. We are testing, actively, varieties that suit the food service sector as well.

 So, with that being said, we are fairly pleased with the accomplishments last year. We are feeling pressure from offshore, as far as product coming in, as Steve mentioned. But there is a strong pull for US-grown product. And I think the Company is well-positioned where we are today. We are, I think, we are best-positioned than anybody to take advantage of that going forward.

 With that, I'll turn it over to any questions.



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Questions and Answers
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Operator   [1]
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 (Operator Instructions). [Richard Rudgley].

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Unidentified Participant   [2]
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 I just wondered if you could give us a bit more information about the pricing pressure at the moment. Do you envisage it's going to go on for the rest of the year? And is there anything you can do about the produce that's being, as I understood it, falsely labeled as greenhouse-grown? And, finally, is this affecting your business up in -- that's coming out of British Columbia?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [3]
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 Okay. When we look at -- first of all, on the tomato pricing pressure, we grow multiple varieties of tomatoes. So that pricing pressure was not on every variety we grow. It was on specific varieties. And our main current variety is TOV, and that's where the greatest pressure was. So that's why we felt the impact. But on a number of different varieties, we didn't feel that. And there was really no degradation of price in our relationships with our customers that are on long-term contracts.

 What's happening in Mexico is almost identical to what has happened in Canada back in the 1990s, ending sort of in 1999, 2000. If you really go back to 1980, where the greenhouse tomato was 1% of the retail market, estimated today probably at 75%. So there was a huge penetration into that market? And that drove the Canadian industry to go from 500, 600 acres back in the 1980s to over 2000 in a very short time. And the rate of that growth overshadowed the rate of consumption in the US. And we saw a similar, exactly similar, pricing pressure. And in 2000, that rate of growth, as far as new acreage in Canada, plateaued; and, to this day, has really not increased at all, maybe a couple percent. But most of that is in just changing technology. The US, throughout those years, did not really grow, in terms of additional assets in the US.

 However, after Mexico, the Mexican industry started the same aggressive growth. Part of it was fueled by EC-backed loan guarantees through Spanish greenhouse builders into Mexico, and the fact that there was a much larger void during the winter months than the rest of the year. And that started driving a huge increase in Mexico. What we see now is -- and I believe that we'll start seeing a plateau, again, in Mexico of the rate of growth as it's becoming to a saturation point on a number of the core varieties.

 And, how long that will last, it's hard to say. But I would say we are probably in it this year. Although what we've seen is, changes in the returns where we see it being -- on our quarter-by-quarter basis last year, we did pretty strong on pricing in the second and third quarter, traditionally. We did not, and that's because the crop cycle in Mexico is more or less out during the summer. So I think we are going through realignment.

 And as far as what we are doing with the labeling ourselves, and the two other major greenhouse producers in British Columbia and in California, we have gotten together and we formed the Certified Greenhouse Association. And, we are participating on the Board, and funding that between the three of us, and going out for greater participation of growers who meet the greenhouse definition. One of the issues is that the United States does not have a greenhouse definition. So, when product comes across the border -- what with the exception of California is the only state -- so when product comes across the border -- if it is, in fact, a field product in a greenhouse box labeled greenhouse, there is no definition. So it can't be policed.

 California passed a legislation defining greenhouse, and has now stopped product that is not -- does not meet that definition, which is basically a high-tech definition of greenhouse. And we are taking that to the other border states, Arizona and Texas -- and, simultaneously, the associations working with the US government, CADA, to establish those guidelines. So, we have an aggressive program to address that. It may take time, though, as we're working in a political venue.

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Operator   [4]
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 [Andy Chrystal].

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Unidentified Participant   [5]
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 I was just wondering, in terms of product variety, if you're able to switch over to your greenhouses to other varieties in order to diversify away from tomatoes. And what percentage of your production is coming from tomatoes?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [6]
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 Well, Village Farms, probably 95%, 96%. Last year, we started producing cucumbers, and we are doubling that acreage. But within the tomato category, again, some of the new varieties we have are very strong and being very well received. So it's not a question of just diversification into cucumbers and peppers and eggplants and even possibly strawberries in the future. But within the tomato category, especially where we are representing a product that has a strong demand and we have the exclusive intellectual property to it, we're going to push that more in crop diversification. So, a lot of the product that we market to meet our customer needs in fulfilling the capacity needs on peppers and cucumbers have been coming from our partner growers, and, of course, as I mentioned, in the DR, to meet that gap. And our goal is to continue to diversify and expand within the US in these other categories going forward.

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Unidentified Participant   [7]
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 So what would it take to switch over to another product category, such as peppers, in your greenhouse? I know that different types of produce probably require different growing environments. But would it be just as simple as switching over the seeds and optimizing the environment? Or would it be longer growing periods? Or could you talk about that a bit?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [8]
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 In the traditional greenhouses we have, structurally, it would be the same. But again, what would drive that somewhat is the location. Because, as you know, those traditional greenhouses are still vented to the outside climate. So, it's important to pick the right location to enhance the results in the traditional greenhouse. But structurally, they would work. However, humidity, parameters change and other parameters, and the growing system within the greenhouse changes, but it's not dramatic.

 However, within the GATES design, that greenhouse has a closed environment, more or less. We can grow anything in there because all the systems are already in there to manage the difference in both the climate and the irrigation feed. And what really changes is the growing system, but not dramatically. And that's within the tomato, pepper, and cucumber category -- or eggplant, or any type of vine, as well. So, we can make those changes without a huge capital increase.

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Unidentified Participant   [9]
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 And would the number of crop cycles be the same?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [10]
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 Well, with cucumbers, the crop cycles are much shorter. We are probably running five cucumber cycles, five to six per year, as we are growing in our traditional greenhouses. If we expand with our GATES technology, that may be reduced to three or four. Peppers, traditionally, are one mono crop. They are a mono crop per year. But we are working on technology, now, to look at enhancing that. I don't want to go into exactly how, because it's sort of intellectual property, but looking at systems to enhance how we grow peppers to make it more profitable.

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Operator   [11]
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 [Chuck Rice].

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Unidentified Participant   [12]
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 A couple of financial and partner questions -- I guess you license your technology with other people. And then, how do you protect that technology is one question, when you license it to them?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [13]
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 Well, we do not license the gates GATES technology to anyone. We have been asked to, on an international basis. And we may consider that, where the product from those licensed greenhouses will not compete in the North American market. We would consider licensing it in North America, predominantly the US and Canada, but only if we tied a very long-term marketing agreement to market the product. We're not going to license somebody to compete with us. And we would control that license accordingly. So we have not done yet. The marketing partners we have, these are individuals who have built their own greenhouses, and they own the assets, and we do the marketing for them.

 We have people in Mexico. All our focus in Mexico has changed to one specific area. It's [Cadestco], Mexico. It's a 7000-foot elevation. It's probably the best climate in Mexico. It's concentrated in one location. And we market for those growers, and those growers are all high-tech growers. They would meet the greenhouse certification that we have. And we don't -- we're not expanding to any other areas of Mexico. But they own the assets, and those greenhouses are traditional greenhouses, mostly like our current ones.

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Unidentified Participant   [14]
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 Where are they located? Where is that in Mexico?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [15]
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 About two hours north-northeast of Mexico City, sort of between Monterrey and Mexico City.

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Unidentified Participant   [16]
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 Got it. And then, on Monahan -- Monahans' facility was CAD42 million, and you expense CAD37 million. If you haven't expensed it and amortized it over let's, say five, years or whatever that would've been, how would that have affected the earnings for this past year?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [17]
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 Chuck, it would've had no impact on this year, obviously, whether under the US depreciation where were able to expense 50% of it or 100% of it, like we were able to undo the tax rules. The benefit, really, is in future years. We have a rather large NOL carryforward in the United States that will last for several years. As the Monahans project kicks in and starts generating substantial cash flow and, obviously, taxable income, that will be offset by our NOL carryforward. That's the advantage. It's a future year cash flow benefit.

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Unidentified Participant   [18]
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 And then, on trade payables you were able to expand those CAD4 million. Any --

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [19]
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 A lot of it has to do with the construction cost of the project. The way our bank financing works on our bank term debt is -- which is why it wasn't fully drawn -- is we have to pay the construction costs first, and then we had a monthly draw from the bank, so there's a timing difference.

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Unidentified Participant   [20]
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 It has nothing to do with product and what you're buying from other people, then?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [21]
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 To some extent it does. To some extent our trade payables have to do with what we owe our supply partners. So as we grow that business, the payables will go up. But, for the most part, what you see at year end, the increase in trade payables, is almost -- all has to do with the Monahans project.

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Unidentified Participant   [22]
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 People who talk about new products. Is there something to complement the cherry tomatoes, and things like that, for Michelle Obama's healthy snacks?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [23]
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 Yes, it is. And I mean that's -- one of the drivers -- that's one of the drivers, why we are looking at market segmentation to the food service industry. Because a lot of that supply is coming through the food service channels, as opposed to retail. And the -- getting into the smaller tomatoes that we are growing today, the grapes, what we would consider a one-bite tomato, where you just pop it in your mouth. And the Mini San Marzano -- that packaging from that, whether you are targeting -- we see, in the future, being able to put five or six in a container. And that would go in a school lunchbox is really -- as you know, a lot of drivers today -- McDonald's, I mean, I've just heard the largest consumer of apples, where three years ago they weren't selling any apples.

 So that healthy eating movement, I think, helps us a lot. Being driven by the schools wanting more produce; Disney World, today, is selling more produce rather than just french fries. We see some of these smaller products we make, like the mini cucumbers, where it's a three-bite cucumber, very fresh, juicy. Those -- I wouldn't consider them designer foods, because everything we do is natural breeding. But there's a lot of programs going on that we're working with, to look at smaller fruit and with much higher sugar, much higher Brix content so they're sweeter. Because that's what's driving the youth. And if you look at consumption, consumption of 18- or 20-year-olds and under on produce is very low, like at the 5% level. So where we want to target is working with schools and organizations, to get more younger people eating it. But you need the right product. And the snacking, smaller food is where we think that will be.

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Operator   [24]
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 Richard Rudgley.

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Unidentified Participant   [25]
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 Just a quick follow-up. How big are the NOLs, please?

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [26]
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 The NOLs, we're not projecting to pay any US taxes until 2015 at the earliest.

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Operator   [27]
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 There are no further questions at this time. I turn the call back to the presenters.

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 Michael DeGiglio,  Village Farms International, Inc. - CEO   [28]
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 Thanks, everyone, for your continued interest in Village Farms. And if you have any additional questions or follow-up, please don't hesitate to contact me. Thanks a lot.

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 Stephen Ruffini,  Village Farms International, Inc. - CFO   [29]
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 Thank you. Thanks, Adam.

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Operator   [30]
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 Today's conference call -- you're welcome -- you may now disconnect.






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