Village Farms International, Inc. Q2 FY2021 Earnings Call

Good morning, ladies and gentlemen. Welcome to Village Farms International's Second Quarter 2021 Financial Results Conference Call. This morning Village Farms issued a news release reporting its financial results for the second quarter ended June 30, 2021. 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 the completion of the call. Details of how to access the replays are available in yesterday's news release. Before we begin, let me remind you that forward-looking statements may be made today during and 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 MD&A for the year ended December 31, 2021, and Form 10-Q for the quarter ended June 30, 2021, which are 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. DeGiglio.

Hey, thanks, Reinus. Good morning, everyone. With me for today's call is Village Farms' Chief Financial Officer, Steve Ruffini; and I'm very pleased to have with me Pure Sunfarms' President and CEO, Mandesh Dosanjh, who is at our corporate headquarters here in Orlando for management meetings and will join us for Q&A at the end of the call. So, I would encourage anyone who has some questions for Mandesh to ask him on this Q&A portion of the call. Excited to have you here. For today's call, I'll spend a few minutes highlighting the key takeaways for the quarter, most notably, the continued strong sales momentum at Pure Sunfarms as well as the benefit to our bottom line of operating at scale. Steve will then review the financial results, and I'll return with some concluding thoughts about why, as Village Farms' largest shareholder, I continue to be so confident in our ability to drive continued value near-term, medium, and long-term and then we'll open the call for your questions. So, starting with Pure Sunfarms, Q2 was a record quarter since entering the retail branded market in the fourth quarter of 2019, so almost two years ago. Record retail branded sales were up 22% sequentially, our fourth consecutive quarter of 20%-plus growth and 135% up year-over-year. Record total sales — net sales were up 38% sequentially and 70% year-over-year and a record adjusted EBITDA since launching our retail branded products in October '19, up 165% sequentially and 264% year-over-year to CAD9.1 million. At the top line, the same two drivers that I have discussed on prior calls continue to propel our growth, which continues to outpace the broader cannabis market. Each of these drivers is the result of conscious decisions as part of our go-to-market strategy under the leadership of the Pure Sunfarms' management team, which continues to prove itself to be the best in the industry without any doubt. The first is our decision to initially focus on the dried flower segment of the market, in which we knew we would have a significant competitive advantage and could excel out of the gate to establish our everyday premium brand that consumers would recognize and generate near-term cash flow and profit. So, using Ontario as a proxy, dried flower, including pre-rolled products, still account for more than 70% of all recreational sales on a dollar basis, and that has been remarkably stable for the past several quarters, but what's even more compelling is the continued dollar growth in these categories. Combined dried flower and pre-rolled products grew $30.2 million just from Q1 to Q2, that's five times $6 million in growth from the three largest 2.0 categories combined. Even on a percentage basis, dried flower and pre-rolls meaningfully leaped ahead and outpaced the major 2.0 categories. On top of this, industry profit returns in this category are still sorting themselves out. All of this is not to diminish the importance of the opportunity size in the 2.0 market, but these market trends support our calculated decision to focus first on flower, the biggest opportunity with the biggest return where we believe we can dominate to build consumer and customer loyalty going forward and hit our 20% goal. The second driver of top-line growth is the overwhelming consumer response to our everyday premium products, the foundation of our market share leadership in the dried flower category. For the second quarter, Pure Sunfarms was once again the top dried flower brand within the Ontario Cannabis Store and remained the top-selling brand of dried flower for the 21-month period beginning October 2019 by both dollar and kilograms. And I'm very pleased to report that in the month of June, for the first time, Pure Sunfarms was a top-selling licensed producer of dried flower in Ontario by both kilograms and dollar value, a pro forma repeated in July as well. I'd like to say that again, Pure Sunfarms as a single brand sold more dried flower in Ontario in June and July of this year than any other licensed producer. We know there has been plenty of discussion about consolidation and owning multiple brands to achieve market share in Canada, but as a Village Farms shareholder, I like the economics of growing market share organically, especially with these results and the valuations others are paying for consolidation. I'm also pleased for the first time to comment publicly about the market share performance of Pure Sunfarms in Alberta and British Columbia, our second and third-largest provincial markets. We are comfortable sharing that particular data, which is from a group called Buddi cannabis retail solutions provider because it is compiled from actual sales data from a broad sampling of retail stores in each province, providing an accurate reflection of overall performance in each province. It is the same data we use to manage the business in each of these provinces. The Buddi data shows that Pure Sunfarms is also the number one flower brand by dollar sales in both Alberta and British Columbia. And not only for the second quarter of this year but in every month going back to October of last year, which is as far back as we have the data. Not surprisingly, our brand and product strategy, which has been so successful in Ontario, is also successful in Alberta and BC. Our Q2 results also benefited from a good quarter for non-branded sales as we took advantage of a number of strong margin-generating sales opportunities in the quarter. As a reminder, our non-branded sales must meet a profitability threshold, as well as make sense within the context of our retail branded strategy and competitive strategy. As many Canadian cannabis businesses are still shifting strategies and trying to find their place in the ecosystem, we expect to continue to see more variability in our non-branded sales from quarter to quarter, but we like how we are positioned, and we like the returns from this business. Perhaps most importantly, Q2 was also a quarter that clearly demonstrated the earnings power of Pure Sunfarms as we benefited from the Delta 3 facility operating at full capacity throughout the quarter. In a quarter, that I would remind you benefited from the longer spring and summer days in terms of yield and lower energy costs, but it's not just about economies of scale. With each quarter, we continue to get better and more efficient to continue to strengthen our everyday premium experience for consumers. In cultivation, we are engaging and enhancing bud-size flower quality through improved cultivation and processing techniques and we continue to learn, refine and leverage our improvements in around processes we are doing proprietary work in key areas such as drying at scale as well as enhancing controls and consistency of execution, and we are extending our competitive advantage through innovation. We recently made technology advancements in pre-roll production enabling us to significantly increase output, which contributed to a three-fold increase in our pre-roll sales within the Ontario Cannabis Store from Q1 to Q2, and then we had a record month in July as well, and I will note, we expanded margins due to production efficiencies. We have developed a new proprietary vape formulation through extensive sensory evaluation work to specifically address consumer wants and we are consistently focused on strain development through our 1.1 million soon-to-be 2.2 million square feet of greenhouse area with a particular focus on high-THC strains, some of which we launch in the coming months. All in, Q2 is an outstanding quarter for Pure Sunfarms, not only for its continued strong operational, financial, and market share performance but for the investment groundwork that this performance means for the quarters to come. So before I turn to our produce results, I want to take a moment to be clear about the importance and value of those operations for the future of Village Farms, especially in light of the variation in the produce financials over the past 18 months. Our US produce operations include four high-tech controlled environmental greenhouses, more than 5.5 million square feet with a replacement value greater than $300 million and exceptional experience growing team and labor force and years of operational experience with the specific facilities not dissimilar to our Canadian assets. They are located in one of the best growing climates for cannabis in the continental United States. They can and I firmly believe will become one of the largest and lowest cost cannabis production facilities when we are permitted to operate in the high-THC cannabis market in the US. This is right out of the strategic playbook, and you can see how we are executing this strategy in Canada with the benefit of our Canadian experience, our internal modeling forecasts that these four US facilities are capable of generating at least $1 billion in annual revenue for Village Farms in the high-THC product category. Strategically, we like the underlying value of this option and manage the produce business, targeting breakeven EBITDA to preserve this optionality. Turning to produce performance. Q2 was another strong quarter operationally, and we continue to see the benefits of improvements that we have made in the past year and a half or so. We are also benefiting from our experience and learnings we have gained, also so important, agriculture and managing the brown rugose virus that has impacted tomato crops worldwide, which has negatively impacted our production in the last two years. Multiple breeding programs are underway by multiple seed companies to build in resistance in the short term ahead. So we continue to see the weakest tomato pricing for certain key categories in the past decade as grocery store traffic dwindled and the reopening of away-from-home dining. Industry-wide demand and dried flower supply reflected planning decisions made during the lockdown period. There are signs, however, that tomato pricing is trending back toward normalized pre-pandemic levels, and with our operational improvements and additional leadership, I remain confident that the produce business will achieve its targeted breakeven EBITDA contribution and maintain optionality to leverage this business for higher returns in cannabis in the future. Recently, we had new leadership in our produce business, appointing industry veteran, Eric Janke as Executive Vice President of Sales & Marketing. Eric will be responsible for the overall productivity and effectiveness of the produce sales and marketing team with a particular focus on driving overall sales performance and will also support the corporate team in capitalizing on emerging opportunities in the broader controlled environmental agriculture sector. Eric brings to us more than four decades of experience in the fresh produce and grocery industry, including more than 20 years in executive roles. I'm thrilled to have Eric on board. I'd now like to turn the call over to Stephen to walk through our financial results and summary. Steve?

Thank you, Mike. Before I begin discussing results, I would like to remind everyone that our Q2 2021 results reflect a full consolidation of the Pure Sunfarms business, which we fully acquired in November 2020. As we did in Q1, we have provided segment reporting historical 2020 and current 2021 Q2, a reminder that as we have done in prior quarters, we have provided the Pure Sunfarms results on a standalone basis, which is helpful context as we discuss current business trends throughout this call. Turning to results. Consolidated sales for the quarter were $70.4 million, which compared to $47.6 million in the year-ago period. The 48% increase in sales was primarily driven by the addition of Pure Sunfarms revenues offset by a slight decrease in produce sales. Net loss for the quarter was $4.5 million as a positive contribution from Pure Sunfarms was more than offset by ongoing pricing pressures in the produce business as well as a $1.4 million one-time incremental electricity charge resulting from the Texas storm in February, which I will discuss in more detail shortly. Adjusted EBITDA of $1.6 million was driven by a close to 200% sequential increase in adjusted EBITDA for Pure Sunfarms to $7.4 million for the quarter. Our adjusted EBITDA loss of $3.9 million in the produce business fell short of our breakeven EBITDA target and masks our more positive trends in cannabis. Turning to business segment results. As Mike has previewed, Pure Sunfarms had an excellent quarter. Q2 sales were $24.7 million or CAD30.4 million, which were up 136% from Q2 2020 and up 38% versus Q1 2021 using Pure Sunfarms' functional currency, Canadian dollars. For the fourth consecutive quarter of Pure Sunfarms retail branded sales grew more than 20%, actually 22% sequentially. So in one year, retail branded sales more than quadrupled to $18.3 million or CAD22.5 million for this quarter. The increase in retail branded sales between sequential periods was largely attributable to demand for our everyday premium products. Additionally, many provinces began their COVID-19 reopening plans with capacity restrictions increased, particularly in Ontario, which helped spur demand in the latter part of Q2 2021. Large formats comprise roughly 52% of our flower sales in Q2 versus large formats of 48%, essentially the inverse percentages of Q1, which in part is the reason for our improved quarter-on-quarter gross margin as small format has a higher gross profit than large format. Wholesale or non-branded sales also increased this quarter to $6.4 million or CAD7.9 million, a 121% sequential increase versus Q1 2021. As we have noted before, as Mike has mentioned, wholesale sales are opportunistic and must make economic and strategic sense for our branded business, so they will vary from quarter to quarter depending on available supply and demand from other LPs. Pure Sunfarms' gross margin was a strong 40% in the quarter at the top end of our target range benefiting from an increase in retail branded sales at higher margins due to a percentage increase in small format, the Delta 3 greenhouse facility operating at full capacity for the entire quarter, which reduced our cost per gram produced and a nice gross profit on our non-branded revenues in Q2 as compared to Q1. Since completing the acquisition of the entirety of Pure Sunfarms, we have been required to record a large inventory non-cash write-up in cost of sales for Pure Sunfarms in our statutory results in order to comply with acquisition-related fair value accounting rules. The write-up impact was meaningful and has meaningfully decreased in this quarter to 133,000 versus 2.8 million in Q1 2021 essentially as we've worked through all the flower inventory that existed on the acquisition date in November 2020. As we stated in prior quarters, this is a non-cash charge that should be adjusted for when analyzing the actual operational results of Pure Sunfarms. Adjusted EBITDA of $7.4 million or CAD9.1 million was the 11th consecutive quarter of positive EBITDA and also as a record since the launch of retail branded sales in late 2019. I commend Mandesh and the Pure Sunfarms team as they drove this record profitability from the combination of higher net sales, a stronger gross margin and good cost control management, as I say in hockey, that's a hat trick. Going forward, as our retail partners return to more normalized selling environments, I would expect SG&A to trend higher in order to support our point of purchase sales and continue to increase our market share, especially in flower. Turning to produce; Mike has mentioned the difficult pricing environment for tomatoes, which certainly impacted results. In addition, in late May, we were presented with an extraordinary electricity bill related to the unprecedented Texas storm. You might remember that in February, these storms caused major problems with the electricity grid, leaving the Texas regulator ERCOT to declare an emergency alert level. During the five-day emergency period, the real-time pricing for electricity was more than 100 times higher than normalized February pricing. Our Texas operations chose a small amount of power to run our operational systems, but the maximum pricing of $9,000 per kilowatt-hour resulted in incremental electricity expense of $1.4 million over our normal electricity rates for this period. The original invoice, which we received in late May, was for a considerably higher amount, but after a complete audit and negotiations with our power provider, it was settled and paid in late June. We've included more background about this extraordinary expense, including our plans to mitigate future price instability in the MD&A filed today. As Mike mentioned, our Texas-based operations are strategically important to us, and we want to commend the team for maintaining and operating facilities during those five days, which was no small feat. During the quarter, produce sales decreased 4% year-over-year with higher production volumes offset by lower pricing, as the tomato industry experienced one of the lowest pricing environments in the past 10 years. While pricing is driving lower sales and profitability this quarter, we are seeing higher production volumes as a result of ongoing efforts to improve growing efficiencies. There are also indications that pricing is moving back to historical levels, however, year-over-year comparisons remain challenging through Q3 2021 as Q3 2020 pricing benefited from the 2020 COVID impact on tomato demand with retailers. That said, we are expecting to be back to breakeven produce EBITDA for the back half of 2021. Produce adjusted EBITDA was a loss of $3.9 million, which excludes the $1.4 million incremental electricity expense in Texas. While this is a wider margin than we target, the team continues to work on efficiencies including increasing partner grown produce, which sets us up for the strategic redeployment of the Texas greenhouses when appropriate. I want to underscore Mike's comments relating to the significant cannabis optionality in our Texas operations. These are assets that the team is managing with an ongoing target of breakeven EBITDA. Some periods by 2020 when demand and pricing were favorable will be better than breakeven. Other periods by Q2 2021 when pricing is at 10-year lows will be more challenging to hit this EBITDA target. That said, the team manages for production efficiencies every day, which continues to position both our growing capabilities and our Texas operations as one of the best options for us to enter high-THC in the US when legally allowed. Finally, a few other highlights. In May, we exercised our remaining option to increase our equity investment in Altum to just under 12%. The investment in Altum, one of Asia-Pacific's leading CBD platforms, represents an efficient means for Village Farms to participate in opportunities in this region. During the quarter, we purchased 428,000 common shares with an average price of $9.30 under our normal course issuer bid, which we announced in May. As a reminder, our decision to purchase shares under this program is opportunistic and consistent with our broader capital allocation strategy. As of June 30, 2021, we had $155 million of working capital on the balance sheet, of which $114 million is readily available cash. We've also extended the duration of our operating line of credit and filed a universal shelf registration to take advantage of benefits only available to well-known seasoned issuers when strategically prudent. The combination of a strong balance sheet, continued growth, operational efficiencies, and a very committed workforce and management team puts Village Farms in a position for a strong and prosperous future. And now, I'll turn the call back over to Mike.

Thank you, Steve. Village Farms remains firmly on track to continue the successful execution of our strategies for near-term, medium, and long-term growth and value creation. Always in the concepts of prudent capital allocation decisions and a focus on return on investment. In the near term, Pure Sunfarms business clearly has momentum, sales, profitability, market share and has quickly established itself as a leader in the Canadian retail cannabis market, but Pure Sunfarms is really just getting started. Importantly, our growth over the past year has been achieved without adding any new provincial markets. Adding Quebec, the second-largest provincial market remains our top priority. And let me just say that we would not have added that until we turned on Delta 2 because we need to satisfy our customers day in and day out and with all of our product moving to the other provincial governments, we really need the Delta 2 to come on, which it is next month. This has only been achieved with a very modest contribution from 2.0 products as well, and that category is still very small, but with exciting long-term growth and profitability in which we are and will participate. It has been achieved in a very congested market in which marketing and advertising is not permitted, and we have achieved our results against the backdrop of the most difficult retail environment in our lifetimes. All of this is what continues to give us great confidence in our decision to expand production. To this end, during the quarter, we received approval from Health Canada to begin cultivation of Delta 2. The license increases our capacity at nearly 1.7 million square feet from the 1.1 million, when we continue now with the second half of Delta has completed, will increase our capacity to 2.2 million square feet. We will begin planning the first half of Delta 2 next month with our first harvest targeted for November. As we ramp Delta 2 production up, as always, we will be prudent in our production decisions growing what we can sell to continue to effectively manage inventories. And I'll take this opportunity to remind you that as we look longer term, we have an addition of 2.4 million square feet of production area on the same site as our Delta — at our Delta 1 greenhouse, which we can rapidly convert to grow cannabis to meet future demand, as the cannabis legal market continues to grow and as international opportunities continue to develop. Importantly, for our future cannabis endeavors, Pure Sunfarms business has performed very much as we planned and expected it to. The results of our decades of experience in controlled environmental agricultural growing leveraging our existing high-performance operations and approaching the retail market in a prudent, thoughtful and strategic manner. Our unmatched performance in Canada provides us with an undeniable advantage as we pursue our opportunities in strategically targeted markets around the world. In the United States, we are encouraged by the federal cannabis bill recently brought forward by the Senate leadership. We view it as an integral step in the process of regulatory change that would allow Village Farms to participate in the high-THC cannabis market in the US. As I've discussed on prior calls, we have identified potential pathways to participate in the high-THC market in the US, and we continue to refine multiple strategies that will enable us to move swiftly and aggressively to leverage our success in Canada for the largest cannabis market in the world. These include specific strategies that will enable us to participate in the cannabis market ahead of any conversion of our Texas assets. As I mentioned earlier, our Texas greenhouse operations represent at least $1 billion in high-THC cannabis sales to Village Farms when we can enter that market. We are optimistic that we can continue to see this progress in the months to come and are planning accordingly. Also, internationally, we believe our capabilities and experience in Canada, the first federally legal recreational cannabis market in the world, will be invaluable as we strategically target, likely, the emerging high growth potential markets for investment, again with a focus on return on investment. Our Asia-Pacific-focused partner, Altum International, which recently increased our investment continues to build its initial market in Hong Kong and expects to move into new markets in the near term. Europe, of course, continues to be a major focus area for us and to support the pursuit of that opportunity, we recently added Orville Bovenschen to lead our European cannabis business in the newly created position of Vice President, European Business Development Operations. Orville joined Village Farms' business development operations team with specific responsibility for new business and operational activities in Europe in the cannabis sector. Orville is originally from the Netherlands, has deep cannabis experience including operational expertise held in Canada through a large part of the Pure Sunfarms team and he has extensive relationships in the sector in Europe as well. It is very early days for the European market return to still challenging for the early players, but we do think this market has significant opportunities and we expect to be a meaningful participant in that market. I'm also pleased to welcome Cynthia Sanalello to our corporate team, a newly created position of Corporate Legal Counsel. Cynthia has a critical role as we continue to grow and expand our business, especially as we pursue our US and international cannabis opportunities. She brings public experience both on New York Stock Exchange and TSX-listed companies, having overseen legal responsibilities for M&A, public financing transactions, and joint venture agreements among others. Before I open the call to questions, I'd like to take an opportunity to properly introduce Mandesh. As many of you know, Mandesh joined Village Farms after working for the Ontario Liquor Board where he played a key role in establishing Ontario Cannabis Store, which as you know manages the distribution of cannabis for the retail market in Canada's largest province. I suspect he may have had many opportunities when he decided to join Village Farms, which speaks to our mutual collaboration. We have a great deal of success with Pure Sunfarms and Mandesh and his exceptional team. Their knowledge of the Canadian consumer, the market, and the competitive landscape have enabled us to translate the best growing operations in the country into the best brand in the country. I live by the credo that results matter and Mandesh and his team have delivered those results. So, operator, we can turn it over to questions now.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Aaron Grey with Alliance Global Partners. Please go ahead.

Hi, good morning and congrats on the very nice quarter and Mandesh, great to have you on and congrats on your success over at Pure Sunfarms. So, first question from me, nice job with market share and increasing that with flower, especially with the growing flower segment that we have been seeing. Now, we're starting to hear a number of peers looking to increase their offerings of high-THC strain-specific products. So, through that lens, I wanted to get your input in terms of where you see the flower category evolving over the next six to twelve months and how you see your position as other people look to see your success and try to replicate some of those things? Thank you.

Okay. Aaron, I'm going to let Mandesh answer that call. Go ahead, Mandesh.

Thanks, Mike. Appreciate it. Thanks for the question, Aaron. So, where do I see the flower industry going? I think the trends you're seeing today will carry on and those are high-THC for sure, pricing is still going to be an important factor and consumers like choices and they like variety. So, I think what's important for us is to keep doing what we're doing. It's probably not an overly glamorized answer, but it's just staying the course, consistently executing, making sure our products are readily available and we're getting national distribution and just continuing to work with our retail partners to make sure our product is on the shelf and available. And so to give customers high-THC everyday pricing, then what do I continue to see is you've got to be in stock and you got to have the product available and we got to follow that up with new strains and new availabilities and we've been doing that. We've launched a few new strain-specific products in the last couple of quarters. We just launched some things this past week, and we're going to continue to do that. So, it's going to be a mix for us of being in stock every day with some of our leading SKUs look at Pink Kush being the number one product in Canada. We've got to continue to make sure that's available, but then following that up with great strains that customers want. So, it's still going to be price and potency and all the factors that go into making a great product from terpene levels to moisture content to bud size and density, making sure you're really giving that big appeal to the customers. So those are the trends we're seeing, that's what customers are valuing and we're going to continue to be there. So, hopefully, that answers your question.

No, that's great. That's really helpful. Thanks for that. Second question from me, then just kind of continue on that, particularly for the Ontario market where you guys are doing really well and we heard a couple of weeks ago that apparently they're pushing out, delaying some decisions regarding new products for some time, given your existing SKUs, since you're performing very well with your market share, can you speak to how that puts you in an advantageous position in the near term as Pure Sunfarms continues to have products outperforming, and there might be limited opportunity for others to introduce new SKUs? Thanks.

Yes, Aaron, Mike has sent it back over to me. Absolutely, OCS has adjusted their product call which we know. At the end of the day, they're trying to run the business like a regular retailer and a regular CPG business. I think the amount of product calls and how often they were looking at assortment and changing things in and out, to be honest, it causes havoc, causes havoc with their systems and their processes, listing things through their warehouse. Even on the retailer side, their buy sheets, their order sheets, understanding what's available, what's not, what's new, it just creates a lot of havoc in their supply chain. So, we've fully expected and are aligned with what the OCS is doing and it's how regular CPG and regular retail works. I think looking at launching a bunch of new SKUs going into holiday, it just never works for anybody, it's just not the way regular retail and businesses run. So we commend them, we're working in lockstep with them. How does it impact us? For sure, I think you made a comment, our SKUs that perform well there are going to remain performing well and we're going to keep them in stock, so there's our base business isn't affected by it, it doesn't limit opportunities for new SKUs to go in. I mean we always think six, twelve months out. We're continually looking at the pipeline and communicating with all of our customers and all the provinces about what's coming. So for us, it's just keeping that communication and dialogue open. Alberta and BC have different and Saskatchewan and Manitoba obviously have different protocols for how you list products. So for us, it's just planning correctly and making sure we're in lockstep with how Ontario is doing their product calls and when those new dates are, but we don't anticipate any impacts on our business and there are definitely some benefits in that our base SKUs will continue to perform and sell through.

Hi, good morning. Congrats on the great quarter and thanks for taking my questions.

Good morning.

Maybe just to start off on the home province of Quebec here. Could you talk a little bit more about how that conversation is going to the extent that you can, maybe provide some timing on when you think that you could enter being it's your top priority? And lastly, assuming you do enter, could you talk a little bit about your strategy maybe both on products and pricing? Will you do you see yourself doing anything differently in Quebec than you do in your other provinces?

I'll start out and then, I'll ask for some color from Mandesh as well. So look, Quebec has been a top priority and clearly, the only reason we haven't pursued it prior was that we want to sort of dominate the areas we're in, we want to provide our customers with all the products they need and never be sure. And with the Delta 3 greenhouse, you can see in the numbers that across Canada including Ontario, Alberta, British Columbia, that really takes the bulk of our capacity. So, to go into Quebec and not really have that horsepower behind us, so to speak, with Delta 2 would have just been premature. Now, that Delta 2 is up and running, we start planning out next month. That just doesn't make Quebec a priority, it makes it a reality. And I would just say, we're going to coincide being in Quebec as our plan with the first cultivation of Delta 2, and I'll limit it to that. As you know, Quebec is a limited market compared to the other provincial governments as far as product about — the products that can be sold have no edibles and so on. So flower really dominates in Quebec and it dominates with us as we just discussed. Mandesh, do you want to provide some color?

Yes. I can answer the second part of your question, which was around what would be our strategy and approach. Our approach has been very national and so parts of it won't change for Quebec. However, we also need to be very cognizant that Quebec is a different marketplace. And before we do anything, we'll work obviously to establish the plan and what our plan is, and Mike has given some color around that, but whenever that time comes, we'll then work with our partners, the Board, whoever we decided to work with there in the province and making sure that we're rightsized on assortment, on price, on offering and branding, of course. So, lots to come, but I would tell you not to expect something drastically different, but we want to make sure that we connect with consumers and we do the right thing for the customer, in this case, the SQDC and have the right approach there.

Thanks for that great color. And maybe just switching gears on the existing market that you guys have now, we've heard recently from other producers that there has been a trend towards more flower recently. How do you see that going forward? Do you think that's sustainable and obviously, perhaps tying that back to your production increase? You mentioned that a big part of that strategy is with Quebec, but obviously, there is ongoing market expansion in Ontario as well with the stores coming online. Just a little bit of color there, please.

Well, one with ramping up to another one, so we're doubling our capacity. By this time next year, we'll be at 2.2 million square feet from 1.1 million. So, for those saying that flower is selling more, I don't understand that. I mean, flower has always been dominant. These numbers have always been there. So I'm not sure what others are saying, those numbers have been north of 70% nationally all along. So we are, and we have an array of 2.0 products, as I mentioned in my remarks, and we will and are participating, and we see some traction there, but regarding Ontario specifically, Mandesh, do you want to make some comments on that?

I want to comment on the statement regarding flower. We are seeing more competitors entering the flower market, and you asked for our perspective on this. It seems that more people are coming to the realization that cannabis is fundamentally about flower. When we examine mature markets across North America, it's clear that while concentrates and other 2.0 products contribute to the business, flower will always remain at the forefront. I'm not surprised that other companies are moving into the flower segment, as it has always been the main focus and will continue to be. It's part of our strategy, so seeing others increasing their focus on flower is not unexpected. Additionally, this trend suggests that profits from derivative-based products may be limited, and those markets could become commoditized as well. In Ontario, we are definitely observing growth in store numbers, which is very encouraging and continues to support our momentum. There remains a significant opportunity in Ontario, particularly in areas where there are still many consumers without access to stores, such as Mississauga, Vaughan, and Markham. We are enthusiastic about the developments in Ontario and the ongoing store expansion. We believe many of these new stores will focus on flower, which will drive demand and sales for our products. We are excited about the future.

Yes. And Mandesh was smiling as he was making those remarks on flower because that's providing validation to us that we always knew, and others may I guess just didn't have their model ready to begin with. So thanks, Andrew.

Morning, Mike, Steve, Mandesh.

Good morning.

Thanks so much for taking my question and Mandesh, great to have you on the call and congrats all of you, gentlemen. Terrific, terrific quarter. So yes, I'll start, take the opportunity to ask Mandesh a question. So a few of my questions have already been asked, but really now, with the 40% gross margins, this flower that you're talking about is really dominating the market, and as competition starts to really build, even though they are behind you, they will sort of start trying to yield. How are you trying to really be defensive in the phase, keep your elbows out, defend your market share, particularly given, Mike, you mentioned that many of your competitors are growing by acquisition, whereas you have opted for the more valuable organic growth? So, I guess my question really is how are you planning to really defend your space, particularly as retail opens?

Thanks for the question, Rahul. It's an important one about defending our market and continuing to grow. We focus on what consumers want, which means we need to maintain our product quality. This involves implementing what Mike discussed regarding drying processes and testing new strains. We're pleased with our recent success, but we are always striving for improvement and exploring new possibilities. We need to prioritize quality, strains, and products, and we will keep delivering what consumers are looking for. This is crucial for us. On the retail side, we are in a strong position. Our brand is gaining more traction than ever. I spend a lot of time visiting stores and talking with budtenders. When they hear the name Pure Sunfarms, their enthusiasm is evident because they value our brand and products. We see an opportunity to enhance brand and product awareness in more stores and ensure they are taking full advantage of our product range. Our next steps involve making small adjustments to engage with stores and work closely with the Board to improve our distribution. We need to ensure that stores are aware of our offerings and are ordering appropriately. We are confident in our brand, product quality, and pricing, and as Steve mentioned, we are meeting consumer expectations across the board due to our strong supply chain and product quality. We must keep executing effectively and reinforcing our position. Our approach moving forward is distinct from that of our competitors, focusing on consistent execution within our supply chain.

Thank you for that, Mandesh. My second question is about the Canada-US market, particularly focusing on our direct engagement with clients. The cannabis sector is growing significantly, while the produce business can be somewhat complicated for those less familiar. Stevie has mentioned that costs this quarter are likely to stabilize over the next six months. A key point to consider will be when cannabis revenue surpasses that of produce. Do you have an estimate for when that might occur? Additionally, since your produce business has strong retail connections in the US with Trader Joe's, Walmart, and Whole Foods, how will you leverage those relationships as the US market opens up to enhance your channels?

Well, so as I mentioned, we've been working diligently on entering the US market, which is not going to wait for the conversion of the Texas assets. We see that as a huge advantage for us. We don't think we're behind because unlike Canada, the US market has established itself without being federally legal and I think that's going to drive chain and change in the supply chain and when that happens, we truly believe large scale, low-cost, premium quality shipping at interstate will eventually rule in that market. That won't happen overnight, but we are patient about it. Not to mention, as I said, Texas is behind by far the other states, but it still represents a market as large as Canada in and of itself. That said, upon legalization, there'll be other ways that the supply chain will work including online commerce and cannabis to us as much a segment of Health and Wellness where we want to participate in as well as high-THC, while under the cannabis umbrella. So for us, we will be looking at how we get ready for that sooner than later and I'll leave it at that.

Good morning and thank you for the questions. Great to have you on the call Mandesh with Mike and Steve. Mandesh, maybe you can provide a little more color on the 2.0 products and maybe the slowness of the rollout there, and an update from consumers in Canada and their uptake there? Has it more been the provincial board side of things or specific 2.0 categories not accelerated as quickly as thought? We know that the flower obviously, high-quality flower has been in demand, and it's been tough to get up in Canada, but your thoughts on how 2.0 products roll out in your initiatives and product categories moving forward for Pure Sunfarms?

Sure. Thanks for the question. So specifically on 2.0, our view has always been, it's not about being first, it's about doing something the best and the best way you can. And so, like all things, we weren't the first to the party and we weren't the first on 2.0. So, there is definitely some optimization in work. So, when we think about 2.0, obviously, vapes, tinctures, as well as edibles, those are our three main products. Some of our biggest work lately has been around and Mike commented earlier about some reformulation on our vape side of the business. So, our first entry was on the full spectrum side, strain-specific full-spectrum offerings, really flavorful related to the product that proved to be a smaller segment of the vape market. Full spectrum is only about 15% or so. The bigger part of that vape market is on the distillate, which gives you a higher THC percentage, and we launched one of, if not the highest, vape product; it's a 0.5 gram distillate high-THC, close to 90%. So, following that up with the larger format of 1 gram, very simply what we did there, and then we're looking at some reformulations of and on the distillate side to continue that momentum. So for us, on the vaping, consumers are still looking at the same things that they look at the flower side which is high-THC at the best price. So, we are launching three new formulations, and those should get out to market in the coming months. And so, we'll see how those do. It's nothing super complicated but just continue to look at those formulations and see how we can start to win better on the vape side of the business. Our tinctures are performing well. We've always done well with our high CBD tincture. We've launched a balanced product as well and we're happy with where those go. On the edible side, our all-natural BC fruit juice, vegan, their gummies are doing really well for us and we're going to do some kind of adjustments there with formulation of flavors and size and offering, but listen, Scott, it's not a huge endeavor that we're doing. We're going to continue to rightsize those product categories. We like our position there and we think there's some opportunity for us to grow in each of those segments. We don't have the same market share in tinctures and vaping and edibles that we do on flower, but that doesn't mean we're giving up on it. We're continuing to dial those in with formulations and product offerings, but it's not going to become a massive part of our portfolio, but we're going to see where we can take it. And it's the same things — high-THC, great price, good offering of product and working with customers and consumers to make sure we get the pull-through at stores.

Great. And I appreciate the color. And then maybe just overall circle back on Ontario or what are you seeing on the competitive front, especially after kind of provincial boards have come through their rationalizations here? Are we starting to see less SKUs, less LPs now on the shelf and that's positioning Pure Sunfarms for obtaining its 20% market share over a longer term? And then just maybe a little bit of color on this quarter as far as Ontario with the stores really ramping up the rollout, are you looking to maintain your share on the shelf space or even grow that from a market share standpoint?

Yes. So Scott, Mandesh again. I think I'll take it in two parts, like you asked, are we seeing the impact? Not quite yet. I mean there are still over 100 LPs and hundreds, if not thousands of SKUs there. I think it's just going to take some time for that to sort itself out. Every week Health Canada continues to send out licenses because people are able to get more operations going and that's up to them. So, I don't think we'll see an immediate reduction of LPs and SKUs. I think the OCS will take their time on assortment and these protocols. So we're not quite seeing that impact yet, definitely hopeful that it goes there because I think there's too many to begin with and it creates a lot of noise in the supply chain and how the OCS buyers need to manage it, the warehouse, even the stores like I mentioned before. So, not quite seeing that yet. On how do we continue to grow and win it in OCS, I have mentioned before in one of the previous questions that for us, it's all about supply chain execution and pull-through at the stores. So, we've continued to expand our Ontario sales team. We're still not crazy big like some of our competitors, we really calculate how much spend and how many heads to be hired in the province. But we are expanding our sales team that's on the ground, that's working with retailers day in and day out. And like I said, it's about making sure they understand our full product offering. Last quarter, we launched a Blue Dream SKU which everybody said we were crazy to do because it's been in the market forever. Yet, it was never done our away, at our price point, at our quality and now people are realizing that the Blue Dream SKU that we offer is fantastic, but is a good example; some retailers didn't know that. Pure Sunfarms as a Blue Dream, well, everybody loves your Pink Kush, let me start ordering that. So, those are the type of conversations and dialogs that we continue to have with retailers to make sure they know what products they can find from Pure Sunfarms. So it's execution on the ground to get that pull-through and get that selling because we know that once their customers have tried our products, we continue to be a repeat purchase for them.

Okay. Thank you. There are no further questions at this time. You may proceed. We just want to thank everybody for participating today and the support for Village Farms. We're working hard here and we look forward to our next conversation on the third quarter. Have a great day. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.