Village Farms International, Inc. (NASDAQ:VFF) Q4 2022 Earnings Call Transcript

Village Farms International, Inc. (NASDAQ:VFF) Q4 2022 Earnings Call Transcript March 9, 2023

Operator: Good morning, ladies and gentlemen. Welcome to Village Farms International’s Fourth Quarter and Year-end 2022 Financial Results Conference Call. This morning, Village Farms issued a news release reporting its financial results for the third quarter ended December 31, 2022. That news release, along with the company’s financial statements are available on the company’s website at villagefarms.com under the Investors heading. Please note that today’s call is being broadcast live over the Internet and will be archived for replay, both by telephone and via the Internet beginning approximately one hour following completion of the call. Details on how to access replays are available in today’s news release. Before we begin, let me remind you that forward-looking statements may be made today during or after the formal part of this conference call.

Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements. A summary of these underlying assumptions, risks and uncertainties is contained in the company’s various securities fillings with the SEC and Canadian Regulators, including its Form 10-K MD&A for the year ended December 31, 2022, which will be available on EDGAR. These forward-looking statements are made as of today’s date and except as required by applicable securities law, we undertake no obligation to publicly update or revise any such statements. I would now like to turn the call over to Michael DeGiglio, Chief Executive Officer of Village Farms International.

Please go ahead, Mr. DeGigilio.

Michael DeGiglio: Thank you, Chris. Good morning. And thank you for joining us today. With me are Village Farms’ Chief Financial Officer, Steve Ruffini; Village Farms Head of Canadian Cannabis, Mandesh Dosanjh; and Village Farms Executive Vice President of Corporate Affairs, Ann Gillin Lefever. As for our usual, Steve and I will review the operating highlights and financial results for the quarter, and then we will be available for questions. Let me first begin with the key takeaways for our fourth quarter. First, our Canadian cannabis business now ranks number two nationally and market share after steady growth throughout the year. In fact, our retail branded sales grew 25% year-over-year, while the market grew just over 13%.

That’s nearly twice of that market. We launched multiple brands, notably the original Fraser Valley weed company, Soar and Promenade and we generated 17 consecutive quarter of positive adjusted EBITDA. Importantly, we grew while integrating Rose LifeSciences into our platform. Many times in the past we were asked about getting access to the Quebec market, we did. When we acquired Rose in very late 2021, it ranked 12th in terms of Quebec market share, it now ranks second. This is a great achievement in just one year. And just after quarter and we further expanded our export markets with our first shipment to Israel, and expect additional shipments to other countries in short order. Second in the U.S. Cannabis business, Synergy+ is on track to be a $4 million a year brand in retail in less than one year since launch.

Another outstanding achievement. And once again in Q4 the team’s performance has made balanced health. One of the very few positive EBITDA CBD companies that we know of. Third, Fresh Produce is turning around. 2022 was one of the most difficult years of my long career in the Produce business. In fact, the Brown Rugose virus has cost us $13 million over €˜21 and €˜22 crop cycle in Texas alone. And that’s only in production costs and yield. It does not include the impact on customer relationships, and it does not include the impact of the virus in calendar year 2022 in our Canadian facility, which we had not previously experienced. A significant turnaround for Fresh Produce is on the horizon for 2023, which we will demonstrate in the first quarter of 2023, much as this being driven, encouraging success with the Brown Rugose protocols.

Q4 demonstrated the strength of our strategy, including surgical investments, operational improvements, including AI technology and innovations we made which resulted in the year ending on a much stronger footing than it started in Fresh. With respect to Canadian cannabis, we have read all the same news articles and hear the same pundits that say Canadian cannabis is out of favor with investors. Actually, that all cannabis in North America is out of favor with investment — investors. Despite this, we are — with all of our current challenges, we have worked hard demonstrated operational excellence and have proven our business and built an enviable position. And what other consumer products industry does this kind of growth exist for an industry leader?

I don’t know of one, and who can claim our depth of experience to capture future growth in the industry. It will get better and when it does, we will have a clearer leadership position. Let me spend a few minutes clarifying our strategy. When and since we expanded to cannabis we expected the sequence to be, one, launch in markets where our cultivation expertise would be the basis for a competitive and profitable business model. We chose Canada. Two, maintain optionality to enter the U.S. market, which as a number one single country market for cannabis is a huge opportunity. We assigned a value to the very real optionality about Texas space assets as worth much more, assuming produce broke even. Than starting from scratch in the U.S. were legally permissible, as we have done in Canada.

Which brings me to the last event in the sequence, number three, when the U.S. market legally permits us in our case to enter it, which is permissible by NASDAQ and with a strong preference to convert some of our Texas space assets as we have done and proven in Canada. So how is this working out? On number one as you can see, our results in 2022 despite very difficult market and regulatory conditions in Canada, which have happened all player’s profitability, we have built a very competitive and profitable business model. I give us a solid A grade for our efforts, especially when the vast majority of what we have built we have built organically, not through M&A. Number two, has proven more difficult in 2022. In simple terms, the options to enter the U.S. market ended up costing more than expected due to factors I have discussed for the last three quarters.

2022 hurt the option value. So I’d give us a D for this part of the strategy last year. A number three, our original expectations were that restrictions would be addressed by Washington and the legislative actions in 2022, at least after the midterms at the latest, which we extended later on to the lame duck session ending in January of this year. You probably guessed that I would assign an F to the efforts in Washington. But I’d also give us a C as it’s our job to manage in a regulated market as well, we would never run a business the way Washington was itself. We recognize it to improve our average. To do so we are attacking all assumptions about entering the U.S. market. Starting with the need to improve and de risk of Fresh business results.

We have undertaken the following, we will be reducing the footprint of our Texas assets to improve profitability and focus on cultivation assets. And team in one region in Texas to better service our profitable customers. We have identified and started implementing multiple operational improvements, which will enhance yields and lower costs. And we’re reviewing every relationship focused on those accounts which are most profitable for us, so that we can over deliver to key customers. Regarding factors out of our control climate virus inflation, I’m sure you can appreciate that operators only discuss these when things — when they are putting pressure on the business model, but they are very real across all agricultural businesses. Over our 30-year history and experience dealing with these factors is one reason we have built the top cannabis cultivation operation in the world.

As of the first few months of 2023, inflation and the Brown Rugose virus, which puts tremendous pressure in our profitability in 2022 are abating. I’m not ready to call victory yet but I will call on those in our Fresh business who have been attacked the virus input costs and pricing opportunities. They have made me cautiously optimistic. So to summarize, we have launched a plan to de risk of Fresh operations by attacking the asset base costs and consumer — customer profitability. Our goal is to keep attacking these fronts until we can safely deliver a positive EBITDA contribution, absent any major climate or economic event. We others to stay cozy, we understand that as a business Fresh must contribute to the growth of Village Farms. I will turn it over to Steve for more detailed review of the financials.

Steve?

Photo by Sebastian Gómez on Unsplash

Stephen Ruffini: Thanks, Mike. Before I get into results, just a quick reminder on the impact of the acquisition of 70% of Rose LifeScience on November 15 2021. And therefore, the fourth quarter and annual 2021 results only reflect six weeks of contribution in last year’s comparisons. Turning to the results. Consolidated sales for all Village Farms for the fourth quarter were $69.5 million which was a decrease of 5% from Q4 last year, due primarily to a weaker Canadian dollar in 2022 versus 2021. On a constant currency basis, our year-on-year sales were close to flat, year-on-year down 1%. Higher sales from the Canadian cannabis business were offset by lower sales from Fresh Produce. On a constant currency basis or cannabis sales were essentially 50% of our consolidated U.S. dollar results.

Consolidated net loss for the quarter was $49.3 million or $0.41 per share, compared with a net income of $2 million or $0.02 per share for the same period last year. Our Q4 2022 net loss included the following significant non-operational charges to income due to balance sheet adjustments, specifically an additional $13.5 million. Impairment to goodwill in the quarter related to the value on our balance sheet of the acquisition prices balance health botanicals. This in addition to the June 30 2022 impairment charge of $29.8 million as a direct result of the significant decline in the valuations in other CBD focused appear publicly traded companies. The total impairment of $43.3 million for the year is a significant driver of our reported statutory full year loss of $101.1 million.

We also — in the fourth quarter wrote down in the Canadian cannabis business took an $11 million U.S. or $15 million Canadian charge for aged lower potency flower inventory. Additionally, we took a valuation allowance adjustment to our U.S. deferred tax asset creating significant change in our 2022 tax provision resulting in a $19.2 million charge to earnings in the quarter. These balance sheet adjustments totaled $43.7 million of our reported $49.3 million loss. Consolidated adjusted EBITDA for Q4 2022 was near breakeven at negative $756,000. Compared to positive adjusted EBITDA of $5.1 million in Q4 of 2021. The EBITDA loss in Q4 was — this year was driven by Fresh Produce. Although we saw a considerable improvement compared to Q3. Corporate costs are relatively flat year on year.

As I shift to Canadian cannabis results, I’ll refer the results in Canadian dollars to provide a more accurate gauge of our period-to-period performance amidst exchange rate fluctuations. Our Canadian cannabis operations delivered year on year growth in Q4 of 13% to CAD38.2 million. Retail branded sales for Q4 continued a meaningfully outpaced the market growth at 25% year-over-year. Wholesale sales for Q4 however, we’re down 35% year-over-year, due to continued significant price erosion in the market as distress producers liquidate inventories. This revenue channel can vary widely from quarter to quarter. This was especially the case in Q4. The wholesale pricing environment contributed to our decision to write down CAD15 million of aged and lower potency flower inventory.

As its expected realizable value was reassessed relative to current wholesale market pricing. As it is sold, it will pressure our gross margin target range of 30% to 40%. Excluding this write down which is recorded in our cost of goods sold for Q4 for statutory purposes. Without this charge, our gross margin for the Canadian cannabis in Q4 was 40% at the top end of our stated target range of 30% to 40%. Top from both Q2 and Q3 as we continue to execute on providing high quality everyday priced products. Selling general and administrative expenses for our Canadian cannabis operations for the fourth quarter were CAD9.8 million or 26% of net sales compared to CAD9.2 million or 27% of net sales in Q4 in 2021. And was the sequential improvement following our investments in the end of 2021 in the first half of 2022.

We remain on track to bring SG&A as proportion of sales back into the lower 20% range in 2023. Q4 2022 SG&A includes severance costs of our publicly announced headcount reduction in early Q4. Our Canadian cannabis operations to their 17th consecutive quarter of positive adjusted EBITDA at CAD6.3 million, up from CAD6.1 million in Q4 2021. I will now move to our U.S. Cannabis operations and revert my review back to U.S. dollars. U.S. Cannabis sales for the fourth quarter, which continued to be generated entirely by balance health were $5.3 million, which generated a gross margin of 67%. That compares with sales of $7.5 million and a gross margin of 71% in Q4 last year. With the sales decreased primarily driven by the industry wide challenges, although indications are that we are outperforming the majority of our peers.

Our back half 2022 results were driven in part by the success of our synergy plus line of hemp derived THC products. Adjusted EBITDA for U.S. cannabis was $300,000 compared with adjusted EBITDA of $1.7 million in Q4 of 2021. Now turning to Fresh Produce, although our financial performance continued to be impacted by inflationary pressures, especially for freight and other production inputs, and the volume loss due to the Brown Rugose virus, we delivered a significantly improved quarter driven predominantly by improvements in our Texas operations, which are continuing into early Q1 2023 and are coupled with stronger year on year pricing. Adjusted EBITDA was negative $3 million compared with a positive $700,000 in Q4 of 2021, and notably a considerable sequential improvement from the negative $4.9 million in Q3.

And as expected it really was a first half second half story with adjusted EBITDA for the back half of the year improving to a negative $7.9 million from a negative $16.5 million for the first six months of 2022. Turning now to cash flows and the balance sheet at December 31, 2022, we had $16.7 million in cash and approximately $44.1 million in working capital. During the quarter we had a net cash outflow of $1.5 million net of all operational capital expenditures and financing in the quarter. Subsequent to quarter end Village Farms Management, our Board and our advisors made what we believe to be a prudent decision to raise $25 million through a registered direct offering of just under 18.4 million common shares at U.S. price of $1.35. Together with warrants to purchase up to the same number of shares, which at their exercise price of $1.65 will generate $30 million in additional proceeds.

We made the decision to raise capital last month based upon two factors. First, our best informed assessment of all the 2023 factors outside of our control. The second a failed federal cannabis legislative agenda that might have delivered more efficient capital market fundraising. We felt we had the responsibility to our shareholders, indeed all stakeholders to door up our balance sheet so that we could focus without distraction on executing our operational plan. And now I’ll turn it back to Mike.

Michael DeGiglio: Thanks, Steve. There are a couple of insights with respect to the 2023 start that I would like to close with. First, as you know, we were always evaluating competitive dynamics, innovation and consumer demand preferences. In our current assessment, the Canadian cannabis team is comfortable implementing a price increase on select products which have been communicated in market. This is what a market leader should do. And I know the team will monitor the impact through this initiative. If successful, our leadership in this regard could be a positive inflection point for the industry. Second, as an industry leader, we have an obligation to share our expertise and insights with all of our stakeholders. Recently senior Pure Sunfarms Management participated in a series of meetings with members of Canadian government.

Our message is shared by other LP operators excessive excise taxation is contrary to the government’s own promise to Canadians to keep taxes on cannabis low to support the objectives of legalization, which are keeping cannabis out of the hands of youth and profits out of the hands of criminals, as a key legislative initiative was the availability of a safe regulated product. Yet even with the legal market approaching 5 billion, the illicit market is still estimated to be 40% of consumption, due largely to the huge tax driven price differential. Mission critical investments in the industries businesses, employees, and our communities are very much at risk. The appropriate model of taxation exists in other consumable products industry, we support all efforts to revise excise taxation levels immediately.

And with that, operator, we’ll open up to questions. Thank you.

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Q&A Session

Operator: Our first question will come from Aaron Grey of Alliance Global Partners. Your line is open.

Aaron Grey : Hi, good morning. And thank you for the questions. Hey, how’s it going? So first question for me just want to get a little bit more color in terms of some of the price increases that you indicated on Select products, any more color that you could provide? And maybe on what products or brands? And then how much are you willing to potentially cede some share in order to improve the profits and then margin on that? And then what gave you the comfort to maybe implement from those price increases now just given the market still rather fragmented and still seeing a lot of pricing pressure? So maybe you guys aren’t, you know, deleting brand, but maybe some others not following you do see some share? What kind of gave you the comfort to that now versus waiting for someone returning the market? Thank you.

Michael DeGiglio: Well, thanks, Aaron. Before I turn it over to Mandesh, that was one of the last time that’s became your first question. So I just think, Mandesh, do you want to give some color on that.

Mandesh Dosanjh: Yes, absolutely. Good question. I mean, we’re not going to give a huge amount of detail because there’s a lot we looked at from a competitive set, but I’ll answer some of your bigger points is. And the first one was around share, we don’t — it’s not about seeding share for the purposes of improving margin. We have a pretty robust understanding of what’s happening at the consumer level, what’s driving demand, and just making sure we understand pricing analytics, and where there’s opportunities. I mean, we’re always evaluating. And I think, right now what we see is a key opportunity to improve margin without impacting share. So, always trying to improve margin, maintain or growth share is kind of our strategy.

It’s all about profitable market share, and improving the dynamics there. And we see the opportunity and implemented the opportunity across a couple of our key brands where just demand was outstripping some of the supply, and really just sharpening across pricing sets within assortment in various regions as kind of the market dynamics are unfolding. And why did we feel comfortable? I think it’s the — I know, it’s the strength of our brand, the quality of the consistency of our products, and just the ability to compete in market. And I think any strong CPG company with strong pricing analytics is always going to sharpen their pencil when they think the time is right. And we think the time is right for us right now.

Aaron Grey: Okay, great. Thanks for that color. I really appreciate that. And then just kind of going on top of that, in terms of some of the distressed sale of biomass that you mentioned, just any color in terms of how you think that will kind of unravel in 2023. So looks to be a lot of inventory out there? So how do you expect there to be a lingering impact? And are you comfortable with how you’re leveraging Fraser Valley to compete in that value segment? Obviously, as you feel comfortable the pricing from the earlier contract we just talked about just wanted — so just want to get some other color in terms of the broader market, and more distressed sales and the impact that might happen, guys? Thanks.

Michael DeGiglio: Mandesh?