Q2 2017 Village Farms International Inc Earnings Call

Aug 15, 2017 AM EDT
VFF.TO - Village Farms International Inc
Q2 2017 Village Farms International Inc Earnings Call
Aug 15, 2017 / 03:00PM GMT 

Corporate Participants
   *  Michael A. DeGiglio
      Village Farms International, Inc. - CEO, President & Director
   *  Stephen C. Ruffini
      Village Farms International, Inc. - CFO, Executive VP, Company Secretary & Director

Conference Call Participants
   *  Daniel Pearlstein
      Eight Capital, Research Division - Specialty Pharma and Special Situations Analyst
   *  Russell Stanley
      Echelon Wealth Partners - Analyst
   *  Vahan Ajamian
      Beacon Securities Limited, Research Division - Research Analyst

Operator   [1]
 Good morning, ladies and gentlemen, welcome to the Village Farms International Second Quarter 2017 Financial Results Conference Call. Yesterday, after market close Village Farms issued a news release reporting its financial results for the second quarter ended June 30, 2017. That news release, along with the company's financial statements, are available on SEDAR and on the company's website at villagefarms.com under the Investor's 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 1 hour following completion of the call.

 Details of how to access the replays are available in yesterday's news release.

 Before we begin, let me remind you that forward-looking statements may be made today during or after the formal part of this conference call. Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements.

 A summary of these underlying assumptions, risks and uncertainties is contained in our various securities filings, including Village Farms' current annual information form for the year ended December 31, 2016, and MD&A for the quarter ended June 30, 2017.

 And the press release issued by Village Farms and Emerald announcing the joint venture of all, which are available on SEDAR. 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 DeGiglio, Chief Executive Officer of Village Farms International. Please go ahead.

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [2]
 Thank you Denice. And thank you to everyone on the phone line listening and on the Internet for joining us today. With me for today's call is Village Farms' Chief Financial Officer Stephen Ruffini.

 In terms to the agenda for today's call, I'll begin with a review of the operational highlights for the second quarter including our transformational cannabis joint venture that we announced at the beginning of June. I'll then turn the call over to Steve to review the second quarter financial results in detail. And I'll return to provide an update on the significant progress the joint venture has made in the 2 months since the announcement and outlook for the produce industry.

 Beginning with the Q2 financials at a high-level, our results reflect the ongoing market pricing challenges for our core produce business at an industry level. But also our continued success in managing the business and executing on our strategy with that industry environment.

 Revenues for the second quarter were up slightly year-over-year as higher production of Texas facilities, higher supply partner revenue and a higher average selling price for our products more than offset the impact of a atypical low light level in British Columbia this winter and spring that resulted in a year-over-year decrease in production of 11% through the end of June.

 We remain laser focused on cost of production at our own Village Farms facility and are seeing the positive impact of our efforts in our results. The first half of 2017 has seen a meaningful 5% improvement in cost of production for the first half of the year, driven by the success of our specific initiatives, including technological advancement, the addition of new varieties with greater yield profiles and expanding our presence in food service industry.

 Those of you who've followed Village Farm for some time know that a core part of our strategy is diversification into higher margin alternative crops to maximize the return on our greenhouse assets, our large-scale, low-cost growing expertise and proven operation -- operating capabilities.

 As I've discussed many times in prior calls, as an agricultural company, and especially in the content of the market pricing challenges in the greenhouse produce industry, we are constantly exploring alternative crop opportunities. In particular, for our Canadian operation, which sees about 60% of its output exported to the United States and that's very typical of all Canadian growers.

 2 months ago in June, we took a very significant step forward in that regard with the formation of a equally owned joint venture with publicly traded licensed cannabis produce the Emerald Health Therapeutics for the large-scale, low-cost production of high-quality cannabis using existing state of the art Village Farms' greenhouses.

 Under our agreement, Village Farms has initially contributed our 1.1 million square foot Delta 3 greenhouse facility, and Emerald is initially contributing $20 million in cash to fund conversion of the Delta 3 facility to cannabis production. Importantly, under our agreement, the JV has the option to purchase from Village Farms the other 2 greenhouse facilities in Delta, Delta 1 and Delta 2, at which time Emerald would be required to provide funding for the conversion of those facilities to cannabis.

 In the interest of time, I'm not going to reiterate all of the details of our agreement. They are available in our June 6 news release and in our conference call the following day, both of which are available on the Village Farms' website.

 But what I do want to emphasize here are the key metrics that we, after extensive analysis and based on our 3 decades of large-scale low-cost greenhouse growing experience, conservatively believe the JV can achieve as these metrics underscore our fundamentally transformational this opportunity is for Village Farms.

 For the initial 1.1 million square foot greenhouse, we are conservatively forecasting annual output of 75,000 kilograms of dried cannabis for the entire 4.8 million square feet. That number importantly, and again, based on our experienced analyst -- analyzation, we are confident that we could be the low-cost cannabis producer and have a target of less than $1 per gram, even at the most conservative assumptions around future wholesale selling prices. The future financial contribution of our half of the JV to the Village Farms' bottom line is compelling.

 With each passing week, there's more news articles and industry reports citing an expected near-term shortfall in industry capacity, potentially as much as 300,000 kilograms or more, and [well across] the license producers to set up production. With our estimated, and again, conservative annual yields of at least 75,000 kilograms at the initial facility, and 300,000 kilograms if all 3 facilities are converted, we are well-positioned to play a very meaningful role in the Canadian market.

 With this looming near term shortage, speed to market is obviously a critical consideration for the JV. And the conversion of existing state of the art large scale low-cost greenhouse operations enable us to pursue a very aggressive time line to get to commercial production, which is targeted from the second half of next year.

 I am pleased to report the JV is making steady progress in that regard, and we are on track towards our key milestones. I'll provide some more details after Steve's review of the financials for this quarter. Steve?

 Stephen C. Ruffini,  Village Farms International, Inc. - CFO, Executive VP, Company Secretary & Director   [3]
 Thanks, Mike. In the interest of time, I'm going to confine my remarks to the key metrics for the second quarter. Our full second quarter and year-to-date financial results and discussion are available in our MD&A and financial statements, which are posted on our website and on SEDAR.

 I will also remind you that, all our numbers I will discuss, and most of the numbers in all those filings are in US dollars as that is our common currency with 85% of our sales in the United States.

 Sales for the second quarter of 2017 grew by 2% to $45.5 million from $44.4 million for the same period last year. The increase is primarily the result of a 7% increase in supply partner revenue as those partners expanded their growing area and a 3% higher average selling price for tomatoes, as we continue to be successful in expanding the proportion of higher selling price specialty tomato varieties.

 This was partially offset by the impact of a 2% decrease in tomato pounds produced due to historically low light levels in British Columbia this spring resulting in an 11% year-on-year decrease in our Canadian production. This was partially covered by an increase from our Texas operations in the second quarter of 2017 versus '16.

 In addition, cucumber pricing was 9% lower in Q2 of this year versus 2016. Although in the third quarter, the cucumber pricing trend is higher year-on-year but that's the nature of produce as well as our July Canadian production in 2015 is higher than our July 2016 production. So that the lower light level trend has reversed as well, again the nature of produce.

 Cost of sales increased 2% for the quarter to $42.8 million from $41.9 million for the second quarter of last year, primarily due to a 4% higher supply partner product volume. Our margin on supply partner produce is lower than our own as we are sharing the margin with the grower. The cost for the company's facilities during the quarter was flat compared to the same quarter in 2016. But for the full 6 months, the cost of production at our facilities was 5% lower compared to last year as we continue to focus on lowering this key metric.

 SG&A expenses for the second of quarter 2017 rose by over $800,000 to $3.9 million when compared to the $3.1 million for the SG&A figure for the second quarter of last year, but the increase is primarily the result of 2 noncash items: one, noncash stock compensation granted in the second quarter of this year of just under $400,000, which was tied to the successful launch of the cannabis initiative, as well as, the reversal of the Q1, 2016 year-to-date bonus accrual of $300,000; we reversed that in the second quarter of 2016.

 The year -- so a better comparison is to compare the SG&A for the full 6 months of 2016 to -- 2017. Excluding noncash expenses SG&A expenses were down $75,000 or 1% for the 6 months ended June 30, 2017, versus the 6 months ended June 30, 2016.

 Net income for the second quarter of 2017 improved to $5.1 million from a loss of $800,000 in the same period last year.

 Please note that net income for the second quarter this year benefited from an $8.6 million gain on sale of assets, resulting from the contribution of the Delta 3 asset in exchange for our 50% ownership in the cannabis JV, which was valued, obviously, at $20 million, as Mike mentioned.

 That was partially offset by a lower income from operations and a $2.1 million swing in income taxes to a provision of $1.8 million in Q2 of this year from a recovery of $300,000 in Q2 last year, obviously, stemming from the book gain on sale of assets, just mentioned.

 EBITDA for the second quarter of 2017 was $1.3 million, down from $1.6 million from the second quarter of last year. The decrease was primarily due to the lower production yields at our British Columbia facilities as mentioned, as well as we have less pounds to sell in Q2 of '17 versus '16. As well as a $105,000 increase in cash operating expenses in the second quarter of 2017 versus the second quarter of '16, due to increases in sales and marketing expenditures as well as development expenditures relating to our new venture.

 Turning to the balance sheet, our cash position at the end of the second quarter was $5.4 million. We have access to a $13 million credit line of which $6 million was outstanding at quarter-end. And our long-term debt, which is the Farm Credit of Canada, at the end of second quarter was at $44 million. I will now turn the call back over to Mike. Mike?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [4]
 Thanks, Steve. Following the announcement of our new cannabis venture on June 6, the combined Village Farms and Emerald team immediately set to work with 2 near-term priorities: planning for the physical conversion of the Delta 3 greenhouse to cannabis production; and the development of the application to Health Canada for the cultivation license for the Delta 3 facility.

 And I'll take this opportunity to mention that after seeing first hand our 2 teams working together, as well as the experience, expertise and value that Emerald brings to the table and their collective approach, I am even more confident than I was when we first announced the joint venture and our choice of partner for this tremendous opportunity.

 The initial work towards conversion of the greenhouse is progressing very well. The architectural drawings and blueprints are well underway, subcontracts and consultants have been retained and are working on the final design of the cultural growing system. All of this puts us on plan for the JV to commence actual conversion activities immediately upon receipt of Health Canada's acceptance of the license application.

 And with respect to the license application, as I discussed earlier, speed to market is critical to fully capitalize on the cannabis opportunity. That's a primary reason we chose to pursue cannabis production by partnering with a licensed producer.

 The JV under Health Canada regulations leverage Emerald's existing cultivation license for the Delta 3 facility. Moreover, we are benefiting from Emerald's invaluable experience and knowledge around the licensing regime and process gain from the existing license.

 With the significant progress that we've made to date, we are very comfortable in sharing that we expect the JV to submit the license application in September. With speed to the market as an overwriting objective, our strategy is to work within the existing Health Canada licensing parameters. That is initially pursuing the cultivation license and conversion for 1 quarter of the initial greenhouse or approximately 275,000 square feet to move rapidly to commercial production. We can then expeditiously replicate that initial footprint to quickly ramp up to the full 1.1 million square feet.

 We recently selected a name for the joint venture, Pure Sunfarms Corp. I'm personally very pleased with our choice, which embodies the most important elements of the Pure Sunfarms value proposition: a deep large-scale agricultural heritage, our commitment to and capabilities in organic growing, a long-track record of agricultural product safety and food safety.

 And our strong belief that there is no better input for any agricultural crop than abundant natural sunlight, which not only supports our commitments to the sustainability and growing -- and responsible growing practices we have but -- and quality, but it's tremendously beneficial to our business model in terms of cost.

 We've also constituted the Board of Directors of Pure Sunfarms, which consists of 3 appointees from each of the boards of Village Farms and Emerald.

 To conclude, we are both tremendously excited about and confident in the transformational opportunity before us in our new cannabis venture. Pure Sunfarms is executing on plan progressing as expected towards the key milestone that will drive value going forward.

 The continuing headwinds in the greenhouse produce industry underscore the significance of this new opportunity driving future growth and creating long-term value for our shareholders. And it's unlikely to get easier in near-term.

 The pace of growth of the groceries, which may soon be accelerated by large-scale entry of international discounters, is far exceeding demand. Literally 100s if not 1,000s of new stores will be opened across United States possibly in the next few years. That will only exaggerate the price competition we have seen in recent years. A recent business insider article called it the incoming retail apocalypse.

 We'll also be watching the NAFTA negotiation [study] at the end of August. No one knows how this will ultimately play out over the long-term, but what it does mean is continued pressure on suppliers, including those in the produce industry.

 But I also believe it will create exceptional opportunities for those willing to and capable of taking a leadership role. As one of the oldest, largest and strongest greenhouse growers and one of the only companies to have successfully completed a major acquisition within our industry, Village Farms is very well positioned in this regard.

 As we embark on our exciting new venture in Canada, we remain confident in the future of our core produce business as well. We're now happy to take any questions you may have. Operator?

Questions and Answers
Operator   [1]
 (Operator Instructions) Your first question comes from Russell Stanley with Echelon Partners.

 Russell Stanley,  Echelon Wealth Partners - Analyst   [2]
 Just 2 questions from my end at this point. One, can you give us some background perhaps on the JV with Emerald, and I guess, specifically, if you could, just touch on how it developed and how long it's been in development?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [3]
 What was the last part of the question, I'm sorry, I couldn't hear it?

 Russell Stanley,  Echelon Wealth Partners - Analyst   [4]
 I asked, how long the JV had been in development for. And to the extent you can, can you elaborate on the process you went through in arriving with EMH as a partner?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [5]
 Sure. We actually -- when medicinal cannabis became legal in Canada, we started doing evaluations that far back. And we thought timing sometimes is everything on the entry to a market. So at that point looking at the minimal conversion, and we thought first of all, we really have a tiger by the tail by taking existing facilities and converting them to reduce the capital outlay and ultimately have an impact on being a low-cost producer.

 Because our background is about operating -- everything commoditizes out, every agricultural crop. So we eyeballed that saying where can we eventually be the low-cost producer. And the conversion was the way to go. So we kept doing our internal analyzation, but we realized, based on the regulatory requirements, if we filed a license on our own, we would be at the bottom sort of the list. And we wanted to accelerate that because the speed to market is critical, and we decided to go forward in a combination joint venture with a licensed producer.

 Once we got board approval, we engaged a banker as advisory, and we then pursued conversations with multiple license producers and went through a number of evaluations with them. But in the end chose to go with Emerald for a number of different reasons. So that whole process probably took about 7 months to get through until we made the announcement in June.

 Russell Stanley,  Echelon Wealth Partners - Analyst   [6]
 That's great. And just a follow-up question on that. How much shorter should the application be at this point, given it's a second stream application? How much time do you expect to shave off as opposed to trying to start fresh with a pure greenfield application?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [7]
 I think, I would say a minimum of 1 year we would shave off. I think we feel pretty confident. Health Canada has been issuing licenses more frequently. The capacity needs are clearly evident and published. Emerald's got a great track record. So I think they're taking a lead on that.

 And we anticipate that we would be able to start, have an initial cultivation license sometime mid next year. And that would be quite a bit sooner sort of going to the top of the list as opposed to remaining in sequence at the bottom, because there are hundreds of applications in currently.

Operator   [8]
 Your next question comes from Daniel Pearlstein with Eight Capital.

 Daniel Pearlstein,  Eight Capital, Research Division - Specialty Pharma and Special Situations Analyst   [9]
 If we can -- I guess hypothesize, let's say, the license comes tomorrow, what are some of the steps involved in actually ramping up the operations from both sides of the JV from a human capital and CapEx and logistical complications all entailed? What are some of the steps, the next steps assuming, let's just say, license comes tomorrow?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [10]
 Well, if the license comes tomorrow -- we're already going to start the conversion process well ahead of the license. So if we -- if the license came tomorrow then the facility would be substantially converted for cannabis and we would immediately go into production.

 So the way we've looked at it is the way we structured the joint venture gives the flexibility that Emerald is not tied to having to buy their products from the joint venture, and the joint venture is not exclusively with Emerald. And that was purposely negotiated because, as we ramp up production, we clearly want the opportunity to be able to have numerous customers for our production, even if it wound up being even other LPs on a wholesale basis.

 Because we realize that even though Emerald on the medicinal side is well ramped up for therapeutic and medicinal distribution, the joint venture will find its own way in ramping that up. And depending on what the regulatory process is -- is it going to be branded products, is it not? For instance a lot of our competitors are spending a lot of time and money on the branded side, and we're saying well, it's not really clear, which way it's going to go yet.

 So we're -- sort of don't want to reinvent the wheel and put that -- invest capital without knowing it, so we are a little cautious. But once -- we are a vertically integrated company in the produce side for 30 years so that's what we've done across the board. So we feel confident we can start that ramp-up process on the distribution side when that's made clear what to do. But if the license was tomorrow, we would be gearing up -- we would already be converted. And then, just starting the cultural process to produce output.

 Daniel Pearlstein,  Eight Capital, Research Division - Specialty Pharma and Special Situations Analyst   [11]
 Okay. Thanks for clarifying. Maybe digging a bit deeper in that, what's left in timing or efforts on the greenhouse conversion process?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [12]
 Well, the last thing -- the sequence would be the last thing, would be putting the growing -- the specific growing system in. But that is probably, we don't see that as being overly complicated. And not without sounding arrogant, but I mean, in 30 years we've converted our growing regimes within the greenhouse multiple times for multiple crops. They're all unique.

 And cannabis is unique, but certainly not -- it's not that much different than converting an existing tomato greenhouse to a pepper greenhouse. So that would be sort of the final step in it because the initial focus right now is on the security process, the computer systems, the cannabis systems, the vault systems and those conversions. That's what's happening first, because that's ultimately much more important in getting licensed than the actual cultural system.

Operator   [13]
 (Operator Instructions) Your next question comes from Vahan Ajamian from Beacon Securities.

 Vahan Ajamian,  Beacon Securities Limited, Research Division - Research Analyst   [14]
 Just a couple of quick questions. Regarding the JV, and I guess, the initial 275,000 square feet, I appreciate it's still a little bit early, but has Emerald given any ballpark indication of how much of the production they would like to take themselves versus you having to wholesale or come up with your own retail strategy?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [15]
 I don't have a number for that at this time, no. Emerald is buying quite a bit of product to supplement their own production. So clearly, their market share seems to be growing every day. So by the time we get the license next year I'm not sure how much of that would be. I couldn't give you a specific at this time.

 Vahan Ajamian,  Beacon Securities Limited, Research Division - Research Analyst   [16]
 Sure. Okay. And I appreciate the concept that, by virtue of the JV, you get to sort of leverage or piggy back off of Emerald's license and move to the front of the line. But just to be clear, have you or has the JV actually had conversations with Health Canada with this respect that you can actually get to the front of the line or move significantly faster in terms of application processing time because of the Emerald connection?

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [17]
 Yes. Most definitely. The way that specific tasking has started out is Emerald has taken the lead on the licensing process. Where our great strengths are in large-scale -- scalable large-scale, low-cost agricultural production of any given crop, and the fact that we have our own development expertise, so we can do the conversion with our own folks, as sort of the GC hammering the cost down on capital acquired and getting the cultural side up.

 They have taken the lead, and they have had meetings with Health Canada, so Emerald's leading that charge. And we have received strong confidence that they believe -- they're very confident that's the way it will go. So they are leading that charge.

 Incidentally, I will say one thing about Emerald, it's not just about the license. In the earlier question I answered that doing a JV with a licensed producer was very important to speed to market. But I mean, Emerald has a lot going on, I think sometimes more so than people really know, and what they are doing on the medicinal side in research. So that was a really important component of picking them as a partner.

 We really believe that not just on the therapeutic side but possibly on the pharma side, they have some great possibilities going on. And when we look at the GW pharma model, that to us is sort of the Holy Grail sort of on a medicinal side. And even though we talked on pricing about the recreational side, if it's approved by Health Canada, will one-day commoditize out, we just used a number of $2. That's if you are successful on the therapeutical pharma side those margins can remain very steadfast.

 So Emerald brings a lot of that to the joint venture that we think our shareholders would benefit greatly from as compared to other public license producers. But I hope that answers your question on the confidence they have on leading that charge.

Operator   [18]
 Being there are no further questions queued up at this time I turn the call back over to the presenters.

 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [19]
 Well, thanks everyone for joining us today. We look forward to speaking with you again on the next call and updating you shortly. Have a good day. Thank you.

Operator   [20]
 This concludes today's conference call. You may now disconnect.

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