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

Village Farms International, Inc. (NASDAQ:VFF) Q4 2023 Earnings Call Transcript March 13, 2024

Village Farms International, Inc. misses on earnings expectations. Reported EPS is $-0.08 EPS, expectations were $-0.018. VFF isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning ladies and gentlemen. Welcome to Village Farm International’s fourth quarter and year-end 2023 financial results conference call. This morning, Village Farms issued a news release reporting its financial results for the fourth quarter and year ended December 31, 2023. 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 of how to access the replays are available in today’s news release.

Before we begin, let me remind you that forward-looking statements may be made today during or after the formal part of this conference call. Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements. A summary of these underlying assumptions, risks and uncertainties is contained in the company’s various securities filings with the SEC and Canadian regulators, including its Form 10-K and MD&A for the year ended December 31, 2023, which will be available on EDGAR and SEDAR+. These forward-looking statements are made as of today’s date and, except as required by applicable securities laws, 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.

Michael DeGiglio: Thanks Shannon. Good morning and thank you for joining us today. With me are Steve Ruffini, our Chief Financial Officer, Ann Gillin Lefever, our Executive Vice President of Corporate Affairs, and Patti Smith, Vice President and Corporate Controller. Today I’m going to cover three topics going forward. First, I’m going to spend a few minutes on the fourth quarter and full year; second, I will discuss some strongly positive improvements in our business model, and third, I’d like to comment on recent developments in the Canadian cannabis landscape. First with respect to the year, we delivered positive consolidated adjusted EBITDA with positive contributions from each business. This was a key goal in 2023 which was owned by all our employees, and I thank them for their contribution and I have challenged them to raise the bar even more in 2024.

Some quick highlights – we have restored our fresh produce business with EBITDA now closer to breakeven on an ongoing basis. That’s a $25 million improvement in adjusted EBITDA in 12 months. We are now focused on long term profitability and cash flow. Our U.S. cannabis business continues to deliver steady performance with positive adjusted EBITDA and positive cash flow. We may be the only major CBD hemp player not bleeding cash right now in the U.S. market. The team has succeeded in establishing a strong and stable platform to leverage as opportunities in the U.S. cannabis industry open up. Our expertise and a portion of our Texas space assets remain a transformational opportunity to replicate our Canadian success in the next generation of U.S. high THC cannabis regulations.

In our Canadian cannabis business, our sales growth accelerated again. We delivered our best ever quarter in retail branded sales and in total net sales. This means in Q4, we reclaimed the number two national market share position across all categories, and we are steadily closing the gap on the number one position. Importantly, brand extensions beyond Pure Sunfarms, like Fraser Valley, Soar, Super Toast, and Pure Lane [ph] are adding market share gains across different price segments and form factors. Outside of Canada, we are pursuing opportunities in new emerging cannabis markets. Nine of the country’s best-selling strains in Canada are now being sold across four international medical markets, including the U.K., which we added at the end of 2023.

We are excited about the recent German market developments and have a strategy in place to accelerate international export sales in current markets while expecting to launch products in additional European markets this year. Earlier this year, we started the build-out of our first production facility in the Netherlands. We are proud to be the only North American participants in this large limited license country, the first major recreational cannabis market in Europe. Production is targeted to begin later this year with first sales expected in early 2025. Moving to topic two, operational improvements that have had a direct impact on our go-forward profitability and cash flow. During one of the most challenging years on record for Village Farms in 2022, driven largely by a tough macro environment and a destructive tomato virus, we took a hard look at every business.

We challenged the assumptions behind our growth projections in light of changing industry and capital markets trends. To summarize, against what we expected to be challenging ’23 conditions in each of our industries, we prioritized what we could control, generating cash flow and gaining profitable market share. When we started drilling down on our cash flow generation goals, we could not ignore working capital and in particular inventory levels within the Canadian cannabis business. Our Canadian cannabis team assessed market conditions and made a brilliant move to monetize non-brand spec inventory to capitalize on the tightening of biomass supply and improved pricing as many large scale competitors shuttered cultivation facilities and moved to a lighter asset model.

In doing so, we have improved the overall quality of our inventory – think freshness, and we have moved our operating model to a higher cash conversion, higher inventory turn operation going forward. We have also better visibility into profitable strategic cultivation opportunities as biomass supply conditions in Canada appear to be tightening. This pivot has temporarily impacting our Q4 Canadian cannabis gross margin and adjusted EBITDA, results that otherwise would have been in line with consensus. Steve will describe further on this shortly. As we see cultivation go offline across the industry and inventories tightening, we expect positive market dynamics to benefit our business model. In fresh, the leadership team has embarked on similar improvements with respect to customer profitability and continued cost improvement mentality while executing on plans to improve our yields.

Turning to our U.S. cannabis business, a major operational improvement is the transition of all our gummy production in-house, which is nearing completion. The initiative is supported by our current sales in the U.S. CBD market, where gummies is a preferred form factor, and it further positions us to be ready for whenever the FDA visits CBD, which we expect will focus on stringent GMP standards for cannabis-derived products, including hemp, to which our products already adhere to 100%. Most of our competitors do not adhere to these standards. We expect to be producing 100% of our gummy products in-house by the second quarter, which will ensure we do not forfeit sales due to stock-out conditions, as we did in 2023. Finally, I want to turn to recent developments in the Canadian cannabis industry.

This is our fifth year of cannabis operations. I want to remind everyone that we have achieved without being first in the market with just one acquisition, albeit a good one. We have executed on our original thesis, leveraging our 30 years of leadership in controlled environmental agriculture into a leading profitable cannabis company. As I look ahead for the first time, I’m optimistic about the potential for favorable changes in the industry, and there are several. I’ll start with excise tax reform, where there are two discussions currently ongoing. First, and we believe most importantly, are the reports that Canadian tax authorities are implementing much more aggressive collection efforts for ballooning delinquent payments. We fully support this effort to level the playing field for all producers and to strengthen sustainable industry operating models.

There was already industry fallout which will benefit Village Farms as a leading profitable operator with a strong balance sheet. Second, a review of the onerous excise tax levels was recently included for the first time in recommendations for the federal budget to be tabled on April 16. We commend those that have worked tirelessly on this effort, including industry groups like C3 and ICID [ph], and stand ready to continue to work together to come to an equitable solution which results in a thriving Canada-leading cannabis industry which invests in long term employment, local municipalities, and ultimately pays income taxes, which we all know is a true measure of a successful business. Canada was the first major developed country to legalize cannabis and now as a global leader has the unique opportunity to work alongside its leading licensed producers to invest in its strong future.

The second development in the Canadian industry that I want to highlight is an emerging improvement in the levels of biomass supply. We think there are several factors: the shift of many of our peers to asset-light models, better demand forecasting as the industry matures, and a focus on working capital are factors which each LP controls. The decision on excise tax also helped due to the ongoing conversations with provincial boards who are aligned on supporting sustainable business models. This is a positive for pricing and industry profitability in our Canadian cannabis business, as we continue to widen the gap as a low cost, high consistency quality cultivator with top market share. This includes pricing at retail, where we’re seeing some recent stabilization.

We view these developments positively as it stands as a validation of our founding thesis. Quality low cost cultivation at scale is incredibly difficult. Our three decades of experience is evident in our profitable position and leading market share. Few in Canada have been able to meet this incredibly difficult challenge. I see this as the next leg of growth for the Canadian cannabis industry, and we will take full advantage to extend our lead going forward. Now Steve, I’ll turn it over to you.

Stephen Ruffini: Thanks Mike. Starting with the consolidated numbers for Q4, sales were up 7% to $74.2 million. Net loss narrowed to negative $22.5 million or $0.20 per share, a $27 million improvement from last year. Both the fourth quarter of 2023 and 2022 were impacted by non-cash goodwill impairment on our U.S. cannabis division of $14 million and $13.5 million respectively. Our consolidated adjusted EBITDA improved $11.1 million year-over-year to negative $700,000. With respect to adjusted EBITDA, I will note here that based on feedback and guidance from the SEC during 2023, we no longer add back inventory write-downs to our adjusted EBITDA calculation. Previously reported 2022 adjusted EBITDA figures for Q4 and the full year have been adjusted to reflect this change.

There were no inventory write-downs in any of our divisions in Q4 or for the entirety of 2023. Drilling down on Canadian cannabis results, which I will reference in local currency, Canadian dollars, in Q4, as Mike mentioned, we delivered record net sales and another quarter of positive adjusted EBITDA and positive cash flow. Net sales increased 14% year-over-year to $43.6 million. Of this total, retail branded sales were up 4% to $33.9 million, a new quarterly record. We have continued to see strong branded sales carry over into early 2024 with some sizeable restocking orders from some of our large provincial customers. Non-branded sales continued the growth we saw in Q3 at $7.9 million, up fourfold from Q4 last year and up 27% sequentially.

Some additional color on this growth. During the second half of 2023, wholesale demand firmed up, which gave us a window to strategically capitalize on moving some of our non-branded inventory. It was a good time to be in the market with biomass that is not designated for our branded or other growth areas. For context, during the fourth quarter we sold roughly three and a half times more non-branded biomass volume than the average of the prior three quarters of 2023. Also for context, without these sales, our gross margin on Canadian cannabis would have been more in line with analyst consensus estimates for the quarter, so if you were thinking that we cleaned up our balance sheet this quarter, you would be correct. International sales for Q4 were $1.2 million compared with $3.2 million in Q4 of last year.

Sales in this growth area of our business continued to be lumpy as we were selling into what are essentially start-up mode medical markets. We stand by our goal for sales outside of Canada to contribute 10% of total sales as we continue to build commercial relationships in these markets. Turning to operating profit and cash flow, our Q4 Canadian cannabis gross margin of 23% was below our target due to the heavier weight of non-strategic, lower margin biomass that we sold during the quarter. For context, in Q4 30% of our sales volume was sold below our target gross margins of 30% to 40%. Our branded sales continued to be within our target gross margin range. We are continuing to take advantage of the favorable market conditions to monetize non-branded spec biomass, which will drive additional cash generation with some continued effect on gross margin percentage in the early part of 2024, but we do expect to deliver Q1 in the low range of our traditional target gross margin of 30% to 40%.

Another highlight of the quarter is our continuous cost management mindset with SG&A expenses of $9.1 million, down $1 million year-over-year, which was a 400 basis point improvement as a percent of sales. While our non-branded spec sales for Q4 did enhance our SG&A as a percentage of sales figure, we are expecting continuation of our cost management with the expectation that our 2024 SG&A to sales ratio will be a couple of hundred basis points less than our full-year ratio of 25.6 in 2023. Our Q4 Canadian cannabis adjusted EBITDA was $2.1 million for the quarter, an improvement from Q4 of 2022’s restated adjusted EBITDA. As with gross margin, adjusted EBITDA was impacted by the opportunistic close-out of sales I discussed. We estimate these sales reduced adjusted EBITDA by $1.7 million.

Mike noted our focus on cash flow generation, another area in which we believe our Canadian cannabis division is in a leadership position. For the full year of 2023, Canadian cannabis generated strong cash flow from operations of $18.2 million, which is close to our Canadian cannabis full-year EBITDA of $20 million with capital expenditures of $1.1 million and principal debt repayments of $9.9 million, for a net cash generation of $7.2 million. I will now turn to our U.S. cannabis business. Q4 sales and gross margin were roughly in line with those of last year at $5.1 million or 66%. Adjusted EBITDA doubled to a small but positive $400,000. Net loss, which includes the $14 million impairment charge, improved year-over-year. While we acknowledge the accounting rules driving the impairment charge, it is primarily driven by the ongoing lack of growth in this segment as we continue to await FDA clarity on the commercialization of CBD.

Even so, we continued to generate positive cash flow for both the fourth quarter and the full year. Moving to fresh produce, sales for Q4 increased to $37.1 million, gross margin was in positive territory for the second consecutive quarter at $800,000, while adjusted EBITDA was a negative $600,000 in Q4, which was slightly below our Q3 forecast for the fourth quarter because the seasonal improvement in winter pricing, which normally kicks in in December, was delayed with pricing firming up in January especially on smaller tomatoes, which continued into early March, and we are expecting another quarter of substantive year-on-year improvement for this division. For the year, fresh produce adjusted EBITDA delivered a remarkable $25 million improvement, and as noted earlier, ended the year in positive territory.

Q4 net loss for fresh produce improved by over $16.5 million to negative $4 million – that brings the total improvement for the year to $32.3 million. Switching to cash flow, consolidated cash flow from operations for the quarter was negative $1.5 million. This was primarily a result of an increase in accounts receivable due to our higher sales, which resulted in a net use of working capital of over $2 million in the quarter. Our capital expenditures for the quarter of $1.7 million, or roughly 30% of our total 2023 capex spend, was primarily for enhanced operational pack house equipment for our Texas greenhouses, which will lower our labor costs in 2024 with an expected payback period of 18 months. We’ve also invested capex of roughly $1 million for our Leli Holland project in the Netherlands.

Finally, we paid $1.4 million in recurring quarterly principal payments, resulting in a net decrease in our consolidated cash for the quarter of $5.2 million. Looking ahead to 2024, the first quarter is seasonally our toughest working capital quarter for produce as we gear up our Canadian produce assets, i.e. build inventory in a form of tomato plants in the Delta 1 and Delta 2 facilities, both of which are about to start harvest, so cash flow from these facilities will start in late April. Our Texas crops are performing well, well into the 2023 – 2024 crop season. Our Canadian operations are having a strong quarter of cash generation as a result of our strong fourth quarter sales and early 2024 sales. Our primary capital spend for this year will be our Leli project, which we are forecasting to finance 100% from existing cash and 2024 operating cash flow.

We ended Q4 with $35.3 million in cash and working capital decreased slightly to $79.6 million, both much improved from the end of 2022. Total term debt at the end of Q4 was $48 million, composed of $23 million of fresh produce debt which is due in May 2027, and $25 million of cannabis debt which is matures starting in February 2026. Our total net debt is $13 million, a level that we are very comfortable with. Now I’ll turn the call back to Mike.

Michael DeGiglio: Thanks Steve. I want to reiterate a few comments before the Q&A on why I remain so optimistic as Village Farms’ Founder, CEO, and largest shareholder. One, we are executing on our original thesis that we would build a profitable cannabis company by replicating our best-in-class 30 years-plus in agriculture expertise. We have started 2024 with a tremendous amount of momentum. Second, we are growing our share of the expanding Canadian cannabis market. At the end of February, the gap between our number two overall position and the number one ranked LP has shrunk to less than 300 basis points, and we are not done. Our target still remains 20% market share. Three, our profitable growth model is uniquely positioned to benefit from improving supply dynamics, stabilizing pricing, and excise tax enforcement currently underway within the Canadian market, and finally, we are driving the next level of Village Farms’ growth.

We are pursuing emerging opportunities in medical markets such as Germany and the limited license country of the Netherlands. We stand at an incredible vantage point, and as I told my senior management team, go crush it. With that, Shannon, we’ll turn it over to Q&A.

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Q&A Session

Operator: Thank you. [Operator instructions] Our first question comes from the line of Eric Des Lauriers with Craig Hallum Capital Group. Your line is now open.

Eric Des Lauriers: Great, thank you for taking my questions. First one from me is just on the U.S. cannabis side. With the vertical integration of the gummy production, can you just talk about how that may or may not impact either gross or EBITDA margins going forward, just how to think about that change in the business model there? Thank you.

Michael DeGiglio: Eric, it will essentially allow us to sustain our existing gross margins. We have seen consumers switch from tinctures, which had a higher gross margin than gummies traditionally, but by in-sourcing it, we’ve been able to improve by not outsourcing our gummies, our own gross margin on our gummies, so we believe we’ll continue to sustain our high 60% gross margin. We have additional capacity on that machine as well, so we’re looking at opportunities to assist others as well.

Eric Des Lauriers: Okay, great. That’s very helpful, thank you. Then my other question, just trying to put all these pieces together in terms of margins on the Canadian cannabis side. It’s great to hear that we have some reduced biomass levels, kind of tightening supply, playing to your strengths here. At the same time, we’ve had some of these opportunistic wholesale sales, which certainly makes sense as you mentioned improving quality of inventory, improving the balance sheet, etc. You mentioned, if I heard correctly, that Q1, although there’s still some, I guess elevated wholesale sales, you do expect gross margins to come back to that historical level of between 30% and 40%. Is there anything to consider with respect to EBITDA margins, potentially some ongoing inventory write-downs that you’re no longer adding back, or just–just wondering how we should be thinking about EBITDA margins in this new normalized environment. Thank you.

Stephen Ruffini: Eric, this is Steve. Most of our inventory is spoken for. We’re not anticipating any inventory write-downs. It is agriculture, so things happen, but with our existing inventory as of today, no risk of any write-downs. We continue to move some out of spec, which is generally lower potency, smaller buds, but we have seen increased demand for that and–increased demand and increased pricing, because we think it’s an indication that the market is short, and we’re very comfortable giving the range that we did, that we’ll be able to, even with these opportunistic movements in the non-brand spec inventory in Q1, to maintain our gross margins in the 30% to 40% range.

Eric Des Lauriers: All right, that’s great to hear. Congrats again, and thanks for taking my questions.

Operator: Thank you. Our next question comes from the line of Mike Regan with Excelsior Equities. Your line is now open.

Mike Regan: Hey everyone, thanks for taking the questions. Can you give us maybe a civics lesson on how exactly the Canadian governmental process would work on the potential 10% ad valorem change? We have the standing committee on finance recommended the tax change unanimously, it’s going to be tabled for April 15, and I think the 10-K added the word ‘near’ for when these changes could potentially come. Could you just help us understand what the process is and what we should be looking for on that change?

Michael DeGiglio: Yes, I think Mike, we’re not necessarily–we don’t have any idea what the Canadian government’s timing is, so. There’s just no way to get around it, but we just reflected that there is conversation going on and there are recommendations. Now, it could happen this year, it may not – it could happen in the fall or even next year, but that trend is going there, and the reason we mentioned it, it’s a profound difference for us, profound. Cannabis last year paid more tax to the government than all beer and wine combined, so at some point it will happen and the impact for the industry and for us is huge, so that’s why we brought it up. But we can’t necessarily say it will happen anytime soon, we don’t have any color on that.

Mike Regan: Okay, but I guess in terms of the process, basically it’s going to be tabled for parliament and then they decide whether they’ll pass the law, either accepting or rejecting the recommendation? Is that basically how it would work?

Stephen Ruffini: Yes, this is Steve. That’s basically how it will work, and we do appreciate your work and analysis on the–as Mike mentioned, the substantive impact on our cash flow and EBITDA. You’ve done good work on that.

Mike Regan: Well, thanks. Yes, I guess in terms of how–I guess in terms of that actual impact, I mean, just using the 2023 numbers, you basically sold $150 million of branded cannabis and paid $58 million of excise taxes on it for net revenue of $92 million in U.S. dollars. If the tax became a 10% ad valorem, it’d be 10% of 150, right, so that 58 would go to 92 and the delta would then push up the net revenue? Is that basically how I’m thinking about the accounting correctly?

Stephen Ruffini: We’re paying obviously excise tax on the branded sales. You have to exclude non-branded sales from your calculation. But looking at your report, essentially you’ve done the calculation and we’re comfortable with the numbers that you’ve provided.

Mike Regan: Got it, great. Thanks a lot.

Operator: Thank you. Our next question comes from the line of Aaron Grey with Alliance Global Partners. Your line is now open.

Aaron Grey: Hi, good morning, and thank you for the questions here. First one from me, just in terms of some of the enforcement of tax code and garnishing of payments, have big of an impact do you think that could have in terms of some accelerated shake-out in the market, and have you already started to see some of it in terms of maybe the purchasing patterns of some of the provincial boards as they look to increase the amount that they buy from LPs that they know are in good standing with the CRA, and shift away from some of those that they may have been asked to garnish wages or see that they owe to taxes to CRA? Thank you.