Q3 2017 Village Farms International Inc Earnings Call

Nov 13, 2017 AM EST
VFF.TO - Village Farms International Inc
Q3 2017 Village Farms International Inc Earnings Call
Nov 13, 2017 / 04:00PM GMT 

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

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Conference Call Participants
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   *  Blake Pelham
   *  Francesco Pellegrino
      Sidoti & Company, LLC - Research Analyst
   *  Geoff Kidder
   *  Michael David Potter
      Monarch Capital Group, LLC - Chairman and CEO
   *  Russell Stanley
      Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations
   *  Vahan Ajamian
      Beacon Securities Limited, Research Division - Research Analyst

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Presentation
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Operator   [1]
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 Good morning, ladies and gentlemen. Welcome to Village Farm International Third Quarter 2017 Financial Results Conference Call. This morning, Village Farms issued a news release reporting its financial results for third quarter ended September 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 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 replay 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 those underlying assumptions, risks and uncertainties is contained in various securities filings, including Village Farms' current annual information form for the year ending December 31, 2016, and MD&A for the quarter ending September 30, 2017, and the press release issued by Village Farms and Emerald announcing the joint venture, all of which are made 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, Mr. Degiglio.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [2]
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 Thanks, Christine, and thank you to everyone on the phone line and listening in on the Internet for joining us today.

 With me for today's call is Village Farms' Chief Financial Officer, Stephen Ruffini. In terms of the agenda for today's call, I'll begin with a review of the operational highlights for the third quarter, including significant progress of Pure Sunfarms, our joint venture with Emerald Health Therapeutics for a large-scale, high-quality, low-cost cannabis production in Canada. Steve will then review our third quarter financial results, and I'll return for some concluding comments before Steve and I take your questions.

 So let me begin with the cannabis joint venture, Pure Sunfarms, which I'm pleased to report is rapidly progressing towards commercial production at the existing state-of-the-art 1.1 million square-foot greenhouse facility in Delta, British Columbia, which we refer to as the Delta 3 greenhouse. Our target is to be growing for commercial purposes in the spring of next year and will be ready to sell on or before July 1. Of course, these time lines are always subject to receipt of the required licenses from Health Canada. And as I'll discuss in a moment, we are very encouraged by our progress here as well.

 As a reminder or for those that are somewhat new to Village Farms story, seizing on what we believe to be a transformational opportunity, in June of this year, following discussions with a number of licensed producers, we formed a joint venture with Emerald Health Therapeutics for high-quality, high-volume, low-cost cannabis production.

 Under our agreement, Village Farms has initially contributed one of our 1.1 million square-foot Delta -- or our 1.1 million square-foot Delta 3 greenhouse facility and Emerald's initially contributing $20 million in cash to fund the conversion of the Delta 3 facility to cannabis production.

 Pure Sunfarms has also the option to purchase from Village Farms the other 2 existing operationally state-of-the-art greenhouse facilities in Delta, which we call Delta 2 and Delta 1 facilities, at which time Emerald would be required to provide funding for the conversion of those facilities to cannabis, which, respectively, would add another 1.1 million and 2.6 million square feet for a total potential growing area of nearly 5 million square feet.

 We are conservatively forecasting annual output of at least 75,000 kilograms of dry cannabis for the 1.1 million square-foot Delta 3 facility and at least 300,000 kilograms, again conservatively, if Pure Sunfarms was to exercise its option and expand to the entire almost 5 million square feet.

 The 1.1 million square foot or 75,000 kilos of production alone would make Pure Sunfarms one of the largest cannabis producers in Canada and the world. Pure Sunfarms achieved several critical milestones during and subsequent to the end of the third quarter. Perhaps most importantly, as per the time line we had previously committed to, on September 14, the cultivation license application for the Delta 3 facility, we submitted it to Health Canada. Just 2 business days later, we were informed that the application was accepted for review.

 As I mentioned earlier, we are very encouraged by this process, which is a testament to both the experience of the development team, the meticulous preparation and Emerald's excellent track record of compliance with Health Canada. The application is for a second site cultivation license, which leverages Emerald's existing cultivation license and to which Health Canada gives or -- gives and confers priority relative to the first-time license application. This is one of the reasons we chose to partner with an experienced license producer.

 The other top priority for Pure Sunfarms is the conversion of the Delta 3 greenhouse for cannabis production. During the third quarter, we finalized all of the conversion plans for the Delta 3 greenhouse and following acceptance of the license application immediately began to move forward in earnest. Our plan is to convert the total 1.1 million square feet in 4 roughly equally sized phases. Phases conversions will expedite the overall process and enable us to begin growing and begin generating cash flow much sooner than converting the entire facility all at once. We, like many experts, believe the Canadian market will be short of supply should the federal government follow through with legalization of cannabis for recreational use of cannabis on July 1, and we are determined to be ready with product to sell at that time.

 Physical conversion of the first quadrant is now well underway. All of the security equipment, the growing systems have been ordered and the first wells are scheduled for installation in January. Each quadrant will be composed of multiple grow rooms, such that Pure Sunfarms can continually harvesting products throughout the year with the flexibility to grow shorter- and longer-cycle crops to enable us to strategically tailor our output to customer and market demands.

 Stand by 1 second. We expect conversion of the first quadrant of the Delta 3 facility to be completed, which essentially means that it'll be ready for inspection by Health Canada in February, just 3 months from now. We will overlap the conversion schedules of each quadrant for expediency and plan to start the second quadrant this coming February with a target to have it commercially growing in the beginning of the fall. We expect the entire 1.1 million square foot greenhouse to be operational in the fourth quarter of 2019. All of this puts us on track to achieve our targeted full output of at least 75,000 kilograms of production on an annualized basis, again a conservative estimate in 2020.

 We plan to install supplemental lighting throughout the entire Delta 3 facility to maximize yields and have secured the required 24 megawatts of power on favorable terms. Pure Sunfarms has made tremendous progress in less than 6 months since our announcement to enter the cannabis space. Our people are working flat out to ensure that we are ready for July 1, and I would like to take this opportunity to publicly acknowledge all of the staff across both of our organizations whose tireless efforts have gotten us so far, so fast.

 In our incumbent produce business, which I want to remind everyone is reported entirely in U.S. dollars, we delivered improved performance for the third quarter. Revenues increased 6% year-over-year, EBITDA grew 78% and net income was positive. Although the end of Q3 as well as the beginning of Q4 were impacted by unseasonably warm end of summer, start of autumn in the Northern United States and Canada, we continue to benefit from our success in lowering our cost of production at our company facilities.

 In fact, cost per pound in our facilities were 6% lower in Q3 of this year over Q3 of last year and is 3% lower for the year-to-date numbers. This marks our sixth quarter of improvement out of the last 7. As I'll discuss in a few minutes, large-scale, low-cost growing is in our DNA, and we will be a significant -- at a significant advantage as Pure Sunfarms ramps up its cannabis growing operations.

 We continue to focus on maximizing our margins through exclusive high-margin tomato varieties and continue to be successful in this regard. I'm also pleased to report that Village Farms own Lorabella Blossom variety, which we launched this past October, was just named as one of the 10 finalists in the inaugural Annual Innovation Award sponsored by PRODUCE BUSINESS, a leading industry trade publication. In this ongoing pricing pressure on our commoditized varieties, I am proud of this performance, especially in the context of considerable use of both human and certain financial resources in advancing the conversion of Pure Sunfarms Delta 3 greenhouse operations' cannabis production over the last 5 months.

 I'd like now to turn the call over to Steve to walk through the third quarter results. Steve?

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 Stephen C. Ruffini,  Village Farms International, Inc. - CFO, Executive VP, Company Secretary & Director   [3]
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 Thanks, Mike. In the interest of time, I'm going to confine my remarks to key metrics for the third quarter. Our complete quarter and year-to-date financial results and discussion are available on our MD&A and financial statements, which were posted earlier today on SEDAR as well as on our website. I'm happy to go into more detail during the Q&A or if you want to call me afterwards, that's fine as well.

 I also like to remind you that all our reported numbers are in U.S. dollars. That is our common currency in our produce business. So for the benefit of a lot of our Canadian investors, I'll give Canadian equivalents on my remarks. As Mike just discussed, our produce business had a good third quarter. Sales grew 6% to USD 44.7 million or CAD 56.3 million from USD 42 million or CAD 53.2 million for the third quarter of last year driven by higher volumes from the company's facilities on slightly lower tomato pricing.

 Overall, our cost of sales for Q3 increased 5% to USD 42.4 million or CAD 53.7 million from USD 40.3 million or CAD 51 million in the same period last year, primarily due to higher volumes at the company's own facilities. However, cost per pound at the company's facilities decreased 6%, again our 6 quarter of improved operating results in the last 7 as we continue to have success and are focused on cost reduction. And a lot of that comes out of our continued improvements with respect to our exclusive varieties, which we continue to improve the yield and lower our cost on.

 Selling and general and administrative expense for Q3 were essentially unchanged from the same period last year at $3.4 million or CAD 4.3 million, which again includes back-office support for the new venture, both on the development team as well as the back-office with accounting and other support until that venture stands on its own 2 feet sometime in 2018.

 We reported net income for the third quarter of 2017 of USD 300,000 -- roughly USD 300,000 or CAD 400,000, which is equivalent to USD 0.01 per share, an improvement of USD 1.7 million or CAD 2.2 million from a net loss in the third quarter of last year of USD 1.4 million or CAD 1.8 million. EBITDA was just shy of USD 1 million or slightly above CAD 1.2 million for the quarter, up 78% from just over USD 0.5 million in the Q3 of last year. The improvements in both net income, EBITDA were primarily a result of improved operating results in Q3 of 2017 versus Q3 of 2016.

 And with that, I will turn the call back over to Mike.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [4]
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 Thanks, Steve. So looking ahead, our diversification into cannabis production through our Pure Sunfarms joint venture is a tremendous opportunity for our company, one that allows us to deploy existing state-of-the-art greenhouse assets and decades of proven operating capabilities to a significantly more profitable agricultural product. The market opportunity is forecast to be massive, and we are very well positioned to capitalize on it. In fact, again, using conservative market price and yield estimates, with just the 1.1 million square-foot Delta 3 facility, which represented approximately 10% of our total footprint prior to the joint venture, Pure Sunfarms will generate more revenue than the entire produce business did and have a significant greater EBITDA margins of greater than 50%.

 At Village Farms, we have been growing agricultural products in greenhouses on a large-scale, low-cost basis for 30 years. Our growing team has more than 750 years of combined experience. We have successfully grown everything from tomatoes to chrysanthemums to roses, cucumbers, peppers, herbs and so on. Cannabis is another agricultural product for us. It is unique but no more or less unique than any other crop we've grown, and we've done so with industry-leading quality and at industry-leading cost in many, many countries in the world.

 Like all other agricultural products, sooner or later, cannabis will commoditize. Under our joint venture agreement, Village Farms is not only contributing the physical greenhouse facility but the operational infrastructure, including the know-how, experience and trained labor that enable us to become one of the largest low-cost greenhouse growers of premium produce in Canada and the United States. It is why we are confident that Pure Sunfarms can be the low-cost producer of high-quality cannabis producer in Canada with a conservative target of $1 or less per gram at full production.

 To conclude, our diversification into cannabis production through our Pure Sunfarms joint venture is transformational for our company and will drive significant value for our shareholders. The conversion of this first 1.1 million square-foot greenhouse is progressing ahead of the original schedule, and we are encouraged by our advancement with the application process for our cultivation license.

 With that, I'd like to open up the call to any questions anyone may have.

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Questions and Answers
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Operator   [1]
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 (Operator Instructions) Your first question comes from the line of Vahan Ajamian from Beacon Securities.

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 Vahan Ajamian,  Beacon Securities Limited, Research Division - Research Analyst   [2]
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 Good to see the progression of the conversion for the JV. Quick question on the existing produce business looked at the margins and the EBITDA actually increasing year-over-year this quarter. Is there anything sort of unique or onetime in either this quarter or the prior quarter? Or can we sort of, knock on wood, hope that the -- that business is sort of turning the corner?

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 Stephen C. Ruffini,  Village Farms International, Inc. - CFO, Executive VP, Company Secretary & Director   [3]
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 Vahan, this is Steve. There's nothing unique to the quarter. Again, we continue to focus on managing our cost. The market is what the market is, and we continue to be focused on managing our cost of production on a day in and day out basis. We do focus and continue to try to improve our market share with respect to our exclusive varieties, which have a higher margin than the commoditized tomatoes that, again, they're commoditized because everybody grows in the TOV and the beefsteaks. So we continue -- and that's why we're excited about the launch of things like Lorabella. That's an exclusive variety that's well received by retailers who are willing to pay us a higher margin for that product than the other ones.

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 Vahan Ajamian,  Beacon Securities Limited, Research Division - Research Analyst   [4]
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 Okay. And just looking forward here, I understand that when you convert the first 1.1 million square-foot greenhouse Delta 3, you plan on having essentially the majority of your revenue coming from cannabis. Will you still plan on reporting your financials in U.S. dollar? Or would you consider kind of converting it if most of the revenue and EBITDA starts coming from Canada or cannabis?

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 Stephen C. Ruffini,  Village Farms International, Inc. - CFO, Executive VP, Company Secretary & Director   [5]
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 Well, it's an interesting question we've discussed with PwC because essentially our common currency -- technically, this is a joint venture, so it's one line item in our financials. Although mathematically, you're correct, the cannabis revenues, even our share of them, will essentially -- our common currency would be, if we consolidated it, Canadian dollars. So either we'll report in Canadian dollars or we're just going to have to do as we've -- and press releases have to convert everything to Canadian dollars.

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Operator   [6]
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 Your next question comes from the line of Russell Stanley from Echelon.

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 Russell Stanley,  Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations   [7]
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 Just a couple of questions, just to follow up on the incumbent business. I'm just wondering, to the extent you can say, do you get any feedback from your existing customers on that -- from that front on your decision to get into the cannabis space?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [8]
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 Well, that's an interesting question. We did talk to a number of our marquee customers as we were going through the process. In Canada, it was very favorable, obviously. And in the U.S., for the most -- it was favorable. We only really had one customer that just wanted to know more about it, and they were fine with it. I mean, so as we've said, clearly, we're not entering the U.S. space under any circumstances until which -- if and when it's federally legal. But I think there are many states moving in that direction. So it was a concern, just as a prudent concern, but in the end, that was accepted by all our customers. We have not lost 1 customer over that.

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 Russell Stanley,  Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations   [9]
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 Excellent. That's good to hear. And I apologize for the background noise. I just have a couple more quick questions. With respect to the physical conversion of Delta 3, what are the key remaining milestones there just on a physical conversion?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [10]
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 Well, everything -- we -- as we said, we separate it into quadrants. But let me be clear with that, there is a parallel to all 4 quadrants. It's not like we're doing one solely and then going to start the second 250,000 square feet. We're getting one as a priority to get up and running as quick as possible, but each phase is -- will be in work by, say, February. However, our goal on the first phase is to be fully converted by February. Everything has been ordered, and we're well underway now moving forward with the conversion. So we don't foresee -- at this point, there's nothing on the horizon that indicates that we'll have any issues.

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 Russell Stanley,  Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations   [11]
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 Excellent. And just on -- just given the manufactural cultivation, have you made decisions yet on what your initial strain (inaudible) will be?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [12]
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 I'm sorry. Say that again?

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 Russell Stanley,  Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations   [13]
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 I was asking about strain selection and what progress you may have made on that front.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [14]
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 I can't -- I'm sorry, Russell. I couldn't hear that. There's like a beep in the background.

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 Russell Stanley,  Echelon Wealth Partners Inc., Research Division - Equity Analyst of Special Situations   [15]
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 My apologies. There's a moving vehicle. Just my last question was around strain selection and what progress you may have made on that front at this point.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [16]
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 Well, I mean, that was really a key driver besides -- for doing a joint venture. So with Emerald, we're in those discussions now. And as a key differentiation between medical requirements as well -- the medicinal side as well as the strains for the recreational side. And rather than elaborate on the phone, but I can say that, that's -- those discussions and selection process is well underway.

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Operator   [17]
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 Your next question comes from the line of Blake Pelham from Raymond James.

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 Blake Pelham,    [18]
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 Just, okay, so the first question is the news release by Emerald this morning, is that completion of another step in the process?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [19]
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 I think it's a parallel step in the process. Again, we're front and center on the application process, and I believe they just wanted to add some confirmation and color to it. So as well, I made a quote in that release and that we're pleased with the process moving forward. So...

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 Blake Pelham,    [20]
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 Okay. Second, if the joint venture was to move ahead with Delta 2 and Delta 1, would that require additional licensing requirements or a new license? Or what would the process be there?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [21]
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 Well, for Delta 2 and 1, it would be then sort of a second step license, again just like Delta 3. But Delta 2 and 1 would be 1 process, not 2 separate processes. Because remember, the licenses by Health Canada are based on your address. So being that Delta 3 is directly across the street from Delta 2 and 1, which have the same -- Delta 2 and 1 have the same address and Delta 3 is separate by numbers, the formality is that you'd have to apply for a third or fourth site license.

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Operator   [22]
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 Your next question comes from the line of Mike Bowcott from TD.

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 Geoff Kidder,    [23]
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 This is actually Geoff Kidder in Mike's office with Mike and [Chris]. I want to understand a little bit about the application process for your license. Are you asking for a license that will allow you to produce something like 12,000 or 20,000 kilograms with this first conversion? Is that a number that's reasonable?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [24]
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 Yes. It's actually 18,300 kilograms for that first 250,000. So we separated it basically 4 quadrants. Each 18,000 and change per quadrant.

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 Geoff Kidder,    [25]
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 Okay. And is that to cultivate only? Or is that to cultivate and sell?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [26]
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 First, it will cultivate and then a sell -- the licenses are sort of 3 phase with the initial cultivation then the production and then the selling license.

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 Geoff Kidder,    [27]
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 Right. Yes, I've seen another company stated they've got a big harvest waiting for their license to sell. So I guess, they're sort of -- it is a sort of a 1, 2, 3 step, right? And what about your future sort of sales practices between you and Emerald Health? Maybe you can enlighten us on what you would see in terms of how that 18,000 kilograms get sold, if it gets sold just directly to them as dried bud? And you also say in one of your reports about being able to cultivate and sell higher-end product yourself. So have you looked at extraction equipment for oils and the personnel? Or are you deferring that to Emerald?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [28]
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 No. I mean, that's all in the process right now. So the flexibility we have is that Pure Sunfarms can be a vertically integrated provider all the way downstream, whether -- if it goes retail and if it's specific province, we can brand our products, we can sell wholesale initially, of course, Emerald's requirement. So we have total flexibility, and thus, we're not -- nothing is firm at this point in how we do it. But ultimately, we believe that, like many, oils and creams will be the larger part of the market or even additives in consumer products. So a lot -- the extraction will come onboard and that will be part of the process. But with the demand still outpacing the supply, we have a lot of flexibility in the gear up. And we're staying very tuned to what the legislation's going to be on the downstream on the retail side. So a lot of those decisions will be forthcoming. But out of the gate, with the wholesale prices today, we're still in a very favorable position in providing even other cannabis competitors as well.

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 Geoff Kidder,    [29]
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 So will Pure Sun have its own sort of distribution website and set up like your competitors do with regards to their medical marijuana already? Or is that going to be a separate sort of digital entity out there? Or will it go through Emerald? Like what do you see there when you actually start selling a dollar per gram sort of stuff?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [30]
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 Clearly, on the medical side, that will be Emerald's conduit. That's sort of part of our agreement coming together. When you really look at the capability of Emerald to us, it was a big decision in choosing them as a partner with the direction they're going, the talent they have and the depth of it. So we're very excited to work with them. And on the medicinal side, that conduit will be going through them. They're working on a number of different therapies and cures and so on. However, on the recreational side, that'll be Pure Sunfarms. That conduit, we'll be building ourselves directly and looking at the sale on the recreational side through Pure Sunfarms.

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 Geoff Kidder,    [31]
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 So like your own sort of entity as a website, right?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [32]
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 Absolutely, yes.

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Operator   [33]
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 Your next question comes from the line of Michael Potter from Monarch Capital Group.

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 Michael David Potter,  Monarch Capital Group, LLC - Chairman and CEO   [34]
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 Quick question on what you guys had written here as far as you anticipate having the cannabis production down to about $1 per gram on production costs. And I'm assuming that, that's 75,000 kilograms of production by 2020.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [35]
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 Yes.

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 Michael David Potter,  Monarch Capital Group, LLC - Chairman and CEO   [36]
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 Okay. And what is the -- and is that -- okay. And is that for medicinal? Or is that for recreational or a combination of the 2?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [37]
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 Well, it's a combination of the 2 based on strains that we looked at with Emerald. So if someone approached Pure Sunfarms to grow specific strains, say, a competitor or somebody in the medicinal and that was a product we wanted to grow and the pricing was right, we would definitely entertain doing that. So I don't know -- if there's specific exclusive strain that yield would maybe be different, then, of course, the cost production will be different. But in general, the strains we're looking at with Emerald and the recreational strains, we're very confident at that $1 a pound and under. And by the way, that includes depreciation. When we look at our cost of sales, we always include depreciation. We notice many don't. And in fact, when we look at some of our competitors on the same size, they're reporting yields sort of out of the -- day 1, 25% higher than that 75,000. So we are fairly confident we're going to get above the 75,000, but we want to give ourselves the time to ramp up the production, which could take 1 or 2 crop cycles, 1 or 2 years to get north of 75,000. But where things happened and the way we project our numbers to be more conservative, we just lower the overall yield. That's why we've made the comments that we think ultimately we can be better or it's a conservative yield.

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 Michael David Potter,  Monarch Capital Group, LLC - Chairman and CEO   [38]
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 And where are the wholesale price for cannabis in Canada currently?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [39]
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 Well, I think it's anywhere from $5 to $6. I mean, there's been some reports very recent that it's projected to be as low as $4 in the coming years. So I mean, I can't say for sure right now. I mean, it really -- I guess, it's -- more importantly is where is it going to be in 2020 when all the capacity that's talked about by competitors ramps up. Will that actually happen? Will it not happen? So -- but again, from day 1, we've looked at a $4 per gram price where we've modeled our numbers initially. But on a sustainable basis, we took $2 per gram. And that was not based on 100% output but 50% output of that quality. The extraction rate we budgeted -- we did our budgets at $1. Now that's longer term, and clearly, we don't want to be there shorter term. But we know we have a viable business at those numbers going forward. And that's, in fact, why when we talk about hammering cost of production on our produce side, I mean, it's a key. It's a prudent thing in agriculture. You've got to continue to hammer your cost of production so you're well ahead of any commoditization that may occur. That's how we see it.

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 Michael David Potter,  Monarch Capital Group, LLC - Chairman and CEO   [40]
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 One other question like, I guess, at the core of our business, the facilities in Texas -- I mean, our focus right now, obviously, is to ramp up the cannabis production as quickly as we possibly can and go through that -- and go through the permitting process. I know -- I mean, up until about a year ago, we were still debating whether or not to rebuild our facilities in Texas that were destroyed by the hailstorm several years back. Where does that currently stand?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [41]
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 Well, we did. We did rebuild -- of the 80 acres that were destroyed that was back in 2012, we rebuilt 60 acres of that. So the majority is up. And all the infrastructure surrounding the following 20s in is built. We just have to physically put the structure up. So that's -- so we look at those assets as a tremendous potential going forward. Again, we're not going into the U.S. unless it's federally legal. However, if it is and people have often said, "would you spin off those assets", the answer is absolutely not. Because at the multiples, we looked at those assets today growing vegetables versus cannabis, if and when it should become legal, it's a huge differential. We, without a doubt, are in the greatest growing area in all of Continental United States, bar none. We're at 5,000 foot elevation in the southernmost latitude, at the highest elevation in the U.S. It's great for any crop including cannabis. We have over 5 million square feet of high-tech facilities there. One of the facilities -- that's one of the most advanced greenhouses ever built in the world. So -- and -- but either way, we believe in our produce business as well. And people have often asked, while losing the 10% of the assets you have with Delta 3, keep in mind again, Delta -- the 3 Delta facilities produce more than enough tomatoes for the per capita consumption of the entire province of British Columbia, and 80% of it is still exported to the U.S. due to many Mexican tomatoes coming into Canada. So ultimately, we will look at -- as we say, we look at -- we're looking at acquisition on the produce side, consolidations required, but we will be looking in the future of new facilities in the marketplace in the U.S. going forward. So it really is a tremendous -- we have a tremendous flexibility on the direction we can go in the next few years in the U.S.

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Operator   [42]
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 Your next question comes from the line of Francesco Pellegrino from Sidoti & Company.

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 Francesco Pellegrino,  Sidoti & Company, LLC - Research Analyst   [43]
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 So I had wanted to ask you about that 2020 goal of 75,000 kilograms at an average cost of $1 per gram, what are production volumes? I guess, how do we -- bridge me to that 75,000 kilograms? What's production for 2018 and 2019 looking like volume-wise? And then what would be the associated per gram production cost for those yields?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [44]
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 Francesco, our current model for 2018, assuming we get a license and we're selling by July 1, we're projecting to sell 7,000 to 8,000 kilograms in the 6 months ended in that 250,000, the first quadrant. Because in the phased approach of 2019, we're projecting sales of roughly 35,000 to 40,000 kilograms in 2019 with -- in '20, as we've already said, 75,000 kilograms. Obviously, the quarterly per gram cost will come down. It's a volume business. As we say, a lot of farming is a fixed cost business. So as you ramp up your, in this case, kilograms -- we're used to talking in pounds as tomato growers, but in kilograms in this instance, we'll ramp that down. So we're starting midway between $1 and $2 in 2018. And by the end of 2019, we're below the $1.

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 Francesco Pellegrino,  Sidoti & Company, LLC - Research Analyst   [45]
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 Okay. I was just trying to assess where the operating leverage was going to come as that tiered incremental production comes online.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [46]
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 Really, it kicks in, in 2019.

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 Francesco Pellegrino,  Sidoti & Company, LLC - Research Analyst   [47]
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 Yes. And then, I guess, when I just looked through some of your presentations, you guys are saying by 2020, you'll have an average production cost of $1 per gram, but the industry's going to have a production cost of $2.25 per gram. Could you just help me understand the difference or maybe bridge your competitive advantages as a grower or a hydroponic business that allows you to have this competitive advantage from the cost side?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [48]
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 Well, the $2.25 was industry numbers we had seen, so we didn't put that out saying they were going to be that and we were this. We've just always from day 1 said that we -- in all our models and let's just say when we ramp up in full production, the critical mass is there. So if you take our grower team, if you're growing 18,000 kilos versus 75,000, it just drives your cost down. So let's say, by the end of '19 is where we're approaching that $1. And certainly, we're there in 2020. The comparison was industry numbers people have talked about. But to answer your question, yes, I mean, high tech -- high-value crops worldwide are grown in greenhouses, both medium tech, low tech and high tech. From Japan -- I mean, you could look at the ferocious growth in Russia today, Turkey, the Netherlands, of course, all over, it's been done for 80 years. And it just makes sense to use natural resources as opposed to supplement what you may need to bring in. So when we look at sort of the indoor model and putting aside the fact that we believe you can achieve the same quality, indoor or out, even if a lesser percent -- even if you wanted to take the fact, and I don't buy it, but less -- you would have less output of high quality from a greenhouse, we are budgeting that at 75,000 when we certainly think we can get to 90,000, as an example. But putting that aside, I mean, how can you look at an indoor -- when I look at an indoor facility, and I've toured many, just the CapEx requirements each year to maintain those facilities, the requirements on energy and back up redundant energy, especially if you're using 100% supplemental artificial lighting to get your crop out, you need back up, the removing of heat, the HVAC, I mean, it's just a massive cost. And at some point, I don't think the 2 -- I think the drivers in the greenhouse will eventually well outperform indoor growing. So when we do our comparisons, we're not doing it to other companies that have a greenhouse strategy. It is compared more to a sole indoor grower.

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 Francesco Pellegrino,  Sidoti & Company, LLC - Research Analyst   [49]
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 Okay, that was helpful. And just one question, my final question on pricing. So given the scenario analysis that you had -- that you provided previously just through the different price points, I think it goes from like $2 per gram up to $8 per gram. Given your competitive advantage in regards to being the low-cost producer, what do supply commitments or supply conversations with potential customers currently look like? For example, would you be willing to forego maybe some profits today if you're going to lock in a higher price over the long term with customers given the significant projected supply shortfall that you're forecasting for the industry? Have you had a big customer approach the partnership yet, saying, hey, we're willing to buy X percent of your production at such and such a price over the next couple of years?

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [50]
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 No, we have not had those discussions, although we've had some early discussions with a retailer who may look at the space that is already an existing customer. And that's why I said earlier, we're very keen on seeing what the legislation is. Clearly, Ontario is going to go in a certain direction. It's unknown for British Columbia if it goes retail. Then we would -- even if we had discussions, we would reserve it until we finally see at least initially what British Columbia's going to do because there has been an indication by a retailer that they want to be in the retail side of this market. We have an existing relationship that could be favorable to us. But again, I think everything changes when the rec side goes July 1, and that's just the game changer, just looking at the capacity requirements as opposed to the medicinal side. And I think that's where those conversations will start to happen.

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Operator   [51]
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 There are no further questions at this time. Mike, I turn the call back over to you.

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 Michael A. DeGiglio,  Village Farms International, Inc. - CEO, President & Director   [52]
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 Okay. I want to thank everybody for your continued interest in Village Farms and Pure Sunfarms. We're very excited as we move forward here and looking forward to our next conversation. Thank you kindly for joining.

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Operator   [53]
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 This concludes today's conference call. You may now disconnect.




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