Village Farms International, Inc. Q1 FY2022 Earnings Call

Good morning, ladies and gentlemen. Welcome to Village Farms International First Quarter 2022 Financial Results Conference Call. This morning, Village Farms issued a news release reporting its financial results for the first quarter ended March 31st, 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 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 MD&A for the year ended December 31st, 2021 and Form 10-Q MD&A for the quarter ended March 31st, 2022, which is available on EDGAR. These forward-looking statements are made as of today’s date and except as required by applicable security 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 at Village Farms International. Please go ahead, Mr. DeGiglio.

Thank you, Chris. Good morning everyone. With me for today’s first quarter is Village Farms' Chief Financial Officer, Steve Ruffini, and joining us is President and CEO of Pure Sunfarms, Mandesh Dosanjh, and for the first time, our recently appointed Executive VP Corporate Affairs, Ann Gillin Lefever. The first quarter of 2022 showed continued strong execution and performance from our Canadian businesses, which was unfortunately somewhat offset by the macro challenges facing Village Farms' Fresh, our Produce business. So, let me start with our Produce business. Those who have followed our quarters recently and for the last several years will know that a number of macro factors have impacted our Produce business, both positively and negatively since the onset of COVID. In Q1 of this year, several additional negative factors collided. First, it has been a very good growing season for the industry, both greenhouse and field-grown, leading to an oversupply in all of our products across the market. At the same time, inflationary pressures in freight, labor, packaging, and growing inputs such as fertilizers, as well as ongoing trucker shortages, have created a very challenging cost environment. These cost increases were both profound and swift. The strong growing season actually hurt the industry. The pricing power of our customers was further strengthened by the supply/demand imbalance. We have been trying but have not been able to achieve any material pricing increases with our retailers. This presents a difficult dynamic compared to cannabis. Produce operates in a commoditized free trade market with products that ship across five to six international borders daily. As long as these inflationary pressures and oversupply continue, we will experience pressure on our Produce results. I have seen this before multiple times in the agriculture industry, and we will respond. We are evaluating new initiatives, including marketing partnerships to build more distribution scale, spread our costs, and diversify product offerings. It is likely there will be attrition among produce growers, which will help supply and balance longer term. We understand that reaction. However, even in the currently negative EBITDA environment for everyone, we maintain the highest conviction that our US cultivation footprint and our assets are a powerhouse opportunity for legal recreational cannabis. Our Texas assets have a replacement value of $350 million to $400 million, with the capability of generating at least $1 billion or more in cannabis revenue. We are working to get our fresh business back on track as we assess our options to utilize our unmatched experience and assets for success in the US cannabis market when we can participate. In the early days of the Canadian cannabis business, we were the only ones that had a strategy, the same strategy to leverage existing assets and cultivation DNA. Having done so successfully, we are convinced of our ability to replicate that success in the US, which brings me to the good news for the quarter. Each of our Canadian and US cannabis businesses continued to perform very well operationally and financially, and improve their leadership in their respective consumer markets, even as they invest in future growth. Both Canadian and US cannabis again contributed positive adjusted EBITDA in Q1, as we continue to see the underlying power of the business. Our Canadian cannabis operations, Pure Sunfarms and ROSE LifeScience delivered its 14th consecutive quarter of positive EBITDA, unmatched in the industry. Pure Sunfarms continued to maintain its market share leadership in the dry flower category, remaining the top-selling brand in Ontario, British Columbia, and Alberta during the first quarter. And in Ontario in March, we achieved our best ever share in dried flower by volume sold at just under 16% in what was Ontario's best sales month in its history. We are most grateful to the consumers and budtenders who support our brands and give us ongoing feedback to continue to build market share. And kudos once again to superb management and sales and marketing teams over the past several quarters. They have invested strategically to ensure that we are supported by our retailers across the country. Our investment is clearly paying dividends. Our success has also generated attention among our peers. Last week, Pure Sunfarms announced its partnership with NOYA to bring Cookies Sun-Grown flower to Canada. Pure Sunfarms will grow and process Cookies high-quality whole flower genetics for a range of SKUs with Pure Sunfarms as the LP of record with the provincial boards. This partnership with one of the few global cannabis brands is further validation of the quality of operations and the expertise of Pure Sunfarms and its team. The first Cookies sun-grown products are now available for purchase in Ontario with more to follow. In the coming months, Pure Sunfarms team will begin announcing specifics of the next leg of strategic growth. The plan calls for a transition from a branded house to a house of brands. The question of brand expression has been asked of us many times. We stood by the single brand approach for our first three years as we firmly believe in the everyday premium positioning in the first stages of the asset legal cannabis market in Canada. We wanted to prove our number one position, built organically with a single brand. It’s been an incredible success. As the legal market develops, consumer-led segmentation and their ability to differentiate is evolving. We believe that there are distinct opportunities to address these consumer preferences with additional brand positions. We are extremely excited to share more details as these launches are unveiled to customers and consumers in the very near future. Another area of near-term and long-term growth is export markets. Following receipt of EU GMP certification during Q1 of this year, Pure Sunfarms has been preparing for its first shipment to Europe and Israel. I will note here that there are different paths to EU GMP certification. We intentionally chose to pursue certification in both the jurisdiction and country, Germany with the very highest standards, and we were successful. And to our knowledge, we are the first greenhouse operation in the world to be EU GMP certified. Our best-in-class facilities have been built, trialed and invested in to support both legs of our international and domestic growth expansion. Production-wise, in Q1 Pure Sunfarms operated at full capacity throughout the first quarter. That includes both Delta 3 and the commissioned first half of Delta 2, totaling 1.6 million square feet. Quebec-based ROSE Life Sciences, which we acquired a 70% majority interest in November last year, had an outstanding end to the year 2020 that has continued into the first quarter of 2022 with new product rollouts throughout the first four months to meet the emerging demand for craft, locally grown product and strain variety, including 14 SKUs in Q1 of this year. ROSE has steadily gained market share in Quebec. During Q1, ROSE launched its new brand in Quebec, Promenade, and its 3.5 grams SKU quickly became a top seller based on its excellent quality to price ratio. All of this drove an 85% increase in ROSE's Q1 shipments of their own branded products compared to the fourth quarter of 2021. And based on third-party data, we estimate that ROSE is now a top three licensed producer in Quebec. Production at ROSE's 55,000 square foot indoor facility in Quebec has expanded to meet this demand. And as a reminder, in addition to its own brands, ROSE is also the exclusive distributor for a number of large third-party LPs, including Tilray, Sundial, and Entourage. This momentum has continued into Q2, and we expect it to continue for the balance of 2022. In our US cannabis operations, Q1 was the second full quarter of contribution from Balanced Health Botanicals and a quarter in line with our expectations. The quarter was once again highlighted by strong gross margin and positive adjusted EBITDA contribution. Of particular note, operationally for Q1 was Balanced Health's launch of its Hemp Extracts with leading pet supplement brand, Zesty Paws. Our extract is now in more than 1,000 PetSmart stores in the US via this partnership. So the integration of Balanced Health into the Village Farms family is progressing very well. Over the next several weeks, the team will be gearing up for some innovative cannabinoid product launches. Before I turn the call over to Steve, a couple of additional updates. In the Netherlands, the government has again pushed back the launch of its legal cannabis production program until early 2023 as it finalizes all of the 10 license holders. We are continuing to advance our plans and expect to be ready to go when the program starts. One final note, which relates to Village Farms Clean Energy, which I don't have the opportunity to speak about often. You'll recall that in November 2020, we announced that we were transitioning this business to a more attractive long-term business model based on the conversion of landfill gas to renewable natural gas in partnership with US-based mass energy. Since that time, we've been working diligently to bring this product to fruition. And I am pleased to say that we expect to have some positive news on this front very shortly. I'll now turn the call over to Steve to review the financials, and then I will return with some final thoughts.

Thanks, Mike. First, a reminder on the timing of our acquisitions and their impact on our first quarter 2022 results. Q1 of this year reflects the full quarter's consolidation of Balanced Health Mechanicals, of which we acquired 100% partway in Q3 last year and the first quarter consolidation of ROSE LifeScience’s, which we acquired in November of last year. Consolidated sales for all of Village Farms, Canadian and US cannabis, and Village Farms fresh produce for the first quarter increased 34% year-over-year to $70.2 million from $52.4 million for the first quarter of 2021. The near $18 million increase was driven by higher sales from both Canadian cannabis and fresh produce, as well as the incremental contribution of US cannabis resulting from the Balanced Health acquisition. Consolidated net loss for the quarter was $6.7 million or $0.07 per share compared to a net loss of $7.4 million or $0.10 per share for the same period last year. This quarter's net loss was driven almost entirely by the very challenging macro environment for the fresh produce business. Consolidated adjusted EBITDA for the first quarter of 2022 was negative $6.1 million, compared to a positive adjusted EBITDA of $400,000 in the same period last year. The EBITDA loss this quarter was driven by fresh produce, partially offset by positive EBITDA contributions from both our Canadian and US operations. Corporate costs were $2.5 million compared to $1.5 million, which was driven by incremental audit and Starbucks costs, partially due to the addition of Balanced Health and ROSE, as well as the expansion and support costs for our development projects, in particular, the Dutch coffee shop endeavor in the Netherlands. Looking at our individual businesses, starting with cannabis. Net sales from our combined Canadian and US cannabis operations grew 65% year-over-year to $28.8 million from $17.5 million, with just over half of that growth driven by the acquisition of Balanced Health and the remainder driven by growth in Canadian cannabis. Our Q1 cannabis sales comprised of 41% of Village Farms total consolidated sales, up from 33% for the same period last year. Total cannabis adjusted EBITDA increased 5% year-over-year to $2.7 million from $2.5 million, with a slight decline in Canadian cannabis adjusted EBITDA being more than offset by the contribution of US cannabis. The decline in Canadian cannabis was driven by the incremental increase in SG&A as a percentage of sales related to two factors: the addition of ROSE and the incremental investment in salaries, consulting, and branding costs to support initiatives that have recently launched or have been announced like our EU GMP certification, which Mike mentioned in his remarks. Canadian cannabis operations delivered another solid quarter with growth in sales of 25% year-over-year to US$21.8 million, driven largely by the addition of ROSE's branded sales and distribution management fees, as well as a year-on-year increase in non-branded sales. I will note here that Pure Sunfarms and ROSE are each benefiting from the mutual sharing of operational and market expertise. I'll review our Canadian cannabis results in Canadian dollars, which provides a more accurate gauge of our period-to-period performance, as well as providing the reader the ability to more accurately compare to other Canadian LPs. Our Canadian cannabis operations once again generated strong year-over-year growth in what has emerged as a seasonally softer sell-in quarter for provincial sales in the first quarter across the industry. The early part of the first quarter, as well as the latter part of the fourth quarter experienced a bit of a slowdown as compared to more normalized months. Net sales for Q1 increased 25% year-over-year to CAD27.6 million from CAD22.1 million. Canadian net sales were comprised of 70% retail branded sales, 24% of non-branded sales and 4% of distribution fees and commissions generated at ROSE. 90% of our retail branded sales were dried flower, inclusive of pre-rolled products, with the remaining 10% being derivative products. Gross margin for the Canadian cannabis for Q1 was 34%, firmly within our stated target of 30% to 40%. It was up from 29% in Q1 last year, the primary result of ongoing and strong cultivation efficiencies and production improvements at our Delta facilities. Even having started out with a low cost of production, we have realized year-over-year improvements in Q1 2022 as compared to Q1 2021, which seasonally is a higher cost quarter for us due to our electricity throughout the quarter. The lower year-on-year cost per gram is a result of our expanding footprint as well as improvements in yield and potency, and we achieved this amidst many of the same inflationary cost pressures that our Produce business is facing. The operational results of our grow ops and manufacturing are impressive. Production-wise in Q1, Pure Sunfarms operated at full capacity throughout the first quarter. That's both Delta 3 and the commissioned first half of Delta 2, totaling 1.6 million square feet. And we continue to operate at full capacity today. We remain comfortable with our current production levels but will remain flexible to adjust production if need be. SG&A for the Canadian cannabis operations in Q1 was $8.8 million or 32% of sales, compared with $5.5 million or 23% in the same period last year. Over half of the $3.3 million increase was attributable to the acquisition of ROSE. The remaining increase reflects planned strategic investments to drive market share and sales growth in the Canadian market and the incremental costs associated with the preparation for the start of exports. I am proud to continue to report that our Canadian cannabis operations delivered positive adjusted EBITDA, our 14th consecutive quarter at $2.1 million. This compares with $2.5 million for Q1 of last year, with the decrease due primarily to our planned investment in SG&A that I just described. Turning to our US cannabis operations, which I will now revert back to US dollars. Sales for Q1 were $7 million with a gross margin of 67% and positive adjusted EBITDA of $600,000. These results composed entirely of the operations of Balanced Health, which continues to perform in line with our expectations following the acquisition last year. Turning now to Fresh Produce. As Mike noted, Q1 was a very challenging quarter from a macro perspective, although sales increased 19% for Q1 from last year, driven by higher volumes. We have been unable to pass on the higher freight and other input costs, as Mike discussed to our big box customers due to an oversupply of Fresh Produce in the market, resulting in a negative gross margin of $4.1 million, which drove negative adjusted EBITDA of $6.2 million, compared to a negative adjusted EBITDA of $500,000 in Q1 of last year. Turning now to cash flows and the balance sheet. At March 31, we had just over $41 million in cash and equivalents compared to $58 million at December 31st of last year. And we had approximately $60 million in working capital, excluding cash, compared with $52 million at December 31st. During the quarter, we had operating cash outflows of $9.6 million. As you may recall, our largest produce greenhouse Delta 1 always is a large net working capital investment in our first quarter of every year, as it does not harvest medicine for late March, early April. In Canadian cannabis historically, the Provincial Board's cash payments ramp up in the second and third quarters and back down in the fourth and third quarters. As a result, Village Farms cash flows are weighted to the second and third quarters. The result is we have seasonality in both our Canadian cannabis and produce revenues. During the quarter, we invested just over $8.7 million. We spent $5.3 million in capital expenditures on our existing production facilities, primarily for the expansion of our Delta cannabis operations and another $3.4 million in the form of loans and the convertible note to benefit our initiatives outside of North America. The vast majority of the CapEx required for the completion of the second half of Delta 2 is paid for with the primary cost remaining being the labor cost to complete construction. Our capital position and forecast for improving cash flows will allow us to self-fund our ongoing operations and budgeted 2022 growth initiatives. And now I'll turn the call back to Mike.

Thanks, Steve. So Q1 is a solid start to a year that we believe turns the page to Village Farms' next chapter of success as we pursue high-growth cannabinoid opportunities in North America and around the world. From my position as CEO, but also as Williston's largest shareholder, with our execution each quarter on both our business operations and strategy opportunity, I have more and more confidence in the future of our company to further extend our leadership in cannabis in North America and establish a leadership position in the international markets in which we choose to participate. 2022 promises to be a year of dramatic strategic initiatives across our businesses that will propel our growth and our company to the next level. So with that, we will now open the call to questions, operator. And as the operator polls questions from our analysts, we're going to take a couple of questions that came in via email from our shareholders ahead of the call. Question number one is, how is inflation impacting your overall cost? The impact of inflation in the U.S. is much greater than Canada for one, labor shortages and labor costs are much more restrictive and severe in the U.S. than they are in Canada. The foreign labor program in Canada is much more superior to the one in the U.S. And of course, the transportation, we're shipping much further in the U.S. than we are in Canada. That being said, Pure Sunfarms continues to drive costs down through better growing techniques, more advanced knowledge of cannabis crops and, of course, strain development as an industry. There's a lot of improvement there, and you can see that in our numbers. We continue to lower our costs going forward, whereas in produce, the strains and varieties are much more mature making it hard to get an increase in yield. Growing techniques have been honed over 50 years, so that's a big difference there. Second question, are you currently selling in to go back under the Pure Sunfarms label? Our current strategy is to help ROSE to achieve the number one position in the marketplace. Once that's achieved then we'll reassess Pure Sunfarms brands entering the Quebec market as well.

Thank you. Your first question comes from Aaron Grey, Alliance Global Partners. Aaron, please go ahead.

Hi. Good morning. And thanks for the questions. And congrats on the Cookies partnership. So first question for me, just on the Canadian cannabis business, right? So I heard you guys talk about seasonality during the quarter. Retail was down about 18%. That included a full quarter of ROSE. So I just want to get some further color because the retail data from Hifyre does show pretty strong sales sequentially. So I wanted to know whether or not it was just some of the timing, whether or not you've seen some improvement now quarter-to-date, because it does look like the sell-through at retail remained pretty strong, so it might have just been some of the provincial buying. So I just want to get some more color in terms of some of that seasonality you're seeing, whether or not that's picked up heading into Q2. Thank you.

Yes, I'll start that off and then I'll get some color from Mandesh on it. But we've reported in the past that there is seasonality, and we consistently see that each year. The difference even between the beginning of the first quarter and the end of the first quarter show big differences as momentum was being gained. The provincial boards are all at a different level of buying, depending on how their year is ending and their inventory levels. So I think that reinforced it, Aaron, again, this year, and now we see that momentum gaining.

Absolutely. I think that's a great setup, Mike. And to your point, Aaron, there definitely are some buying patterns. Specifically, what we saw in British Columbia, as an example, is we had a really solid load-in of inventory in Q4, which suppressed some of our shipments in Q1. But what you did see and you're commenting on that is, really strong HiFyre sell-through. So, obviously, our sales are built on the sell-in and then what you see on HiFyre sell-through. So we feel really confident on that sell-through data. And obviously, the timing of the Board isn’t going to impact any of the sell-in, which is our revenue. But, again, the momentum is great. We're seeing the share pickups, and we feel really pleased with the strategies we have in place to carry that momentum forward. And as we start to see the buying patterns normalize and stabilize over multiple quarters, we'll see that revenue pick up.

All right. Great. Thanks very much for that color. Second question for me, right? So you guys talked about moving now to more of a house of brands versus a branded house, starting with Pure Sunfarms everyday premium. It looks like you're going to expand upon that. I know more details are to come. But just wondering if you could provide some color in terms of how you're thinking about it, particularly on the premium side, you do feel like what the current cultivation you have in the greenhouse, obviously, you've done a great job in the everyday premium. Do you guys have the capabilities to kind of move up to a more premium on the flower side, or will you just maybe find that elsewhere on the cultivation, or just how you guys are kind of thinking about leveraging the current asset base to limit different pricing tiers or whether or not you look to find something externally? Thank you.

Well, we'll answer the question the same way, I'll start it off. First, I want to say that we're very confident and excited about the direction. I personally am, I've been briefed very extensively and the timing is perfect for us. The market's ready. We have thought about this for quite some time, and the timing couldn't be better going forward. I don't want to give too much away. So I'll let Mandesh answer the rest of that question to give you some perspective, as far as he can go.

Thanks, Mike and I appreciate that. I definitely don't want to give too much away for the consumer base. But, Aaron, Mike alluded to, everyday premium has been the core of what Pure Sunfarms has started off with. And now the opportunity is there to think about customer segmentation and launch additional brands. So we're going to be launching actually two additional THC brands this year, one pretty imminently in the next couple of months and then one later on in the year. And based on all the work we're doing across our growing as well as our processing, I've alluded to before that we're converting our facility to full hang dry, and we're on track for that. So when you think about implementing a full hang dry on the whole plant drying when you think about implementing, hand manicuring really those premiumized processes onto the flower in addition to the fact that we're launching close to over a dozen genetics this year across those three brands, Pure Sunfarms and the two new ones. We really feel confident in our ability now to attack various parts of the market that the Pure Sunfarms everyday premium was not reaching. So we're going to leave it there, and just hopefully, you can understand that we want to hold some back. But maybe I want to be very clear, our ability to attack different parts of the segment of the market, whether premium or not, we're definitely going to take advantage of that, and you're going to see some really exciting things come out of Pure Sunfarms and Canadian cannabis this year.

All right. Great. Look forward to hearing about it. I'll jump back in the queue.

Thanks, Aaron.

Your next question comes from Andrew Partheniou, Stifel. Andrew, please go ahead.

Hi. Good morning. Thank you for taking my questions. Maybe just starting off on the cannabis side of the business, could you discuss or if you could give a little bit more color on where you are with your production expansion, understanding that you mentioned you're comfortable with current production levels? And a follow-on to the question from Aaron. You mentioned that you could expect to see a rebound in sequential direct cannabis sales, where could we see this going, given where you are in your production expansion? And what's the potential here?

Well, I'll answer the first part of that. So we just – as you know, Delta 3 has been in full production now since the end of last summer. And we started the conversion for Delta 2, 50% of it in production at the end of last year. So by January, it's fully in production that's 1.1 million square feet. So roughly another 500,000 square feet that puts us at the $1.6 million fully in production, everything we're producing. We sell, as you know, we don't grow what we can't sell. So as Steve mentioned in his remarks, everything has been paid for, for finishing the second half of Delta 2, except the labor to just install the parts. Everything is on site. We reserve doing that based on the delays we've seen due to COVID on our EU GMP certification. We've talked about that last time that was delayed probably for about 1.5 years. So we wanted to be prudent with that. Now that we've received that and we're making headway to start our first shipments in the near future, coupled with Israel. And we started, as we said, shipping to Australia. That, combined with further market share penetration in Canada and working with ROSE as well we see our ability to gear up very quickly for another 25% increase in our current capacity over the probably sometime in early to mid-2023.

Yeah, Mike, there's not a whole lot to add. I think you framed it up really well in that. We've always matched our supply to our demand. And given what you just talked about with the European initiatives with the ROSE business, or shipping in biomass with the expansion into other provinces. You earlier commented on the partnership with NOYA and then we just answered Aaron's question on the expanding brand capabilities. When you think about all those components coming together, we see a tremendous amount of upside and continued revenue growth. I'll flip it over to Steve if there's anything he wants to add. I know we don't give guidance, but we feel very positive on the momentum we're building within Canada and in some of these international markets. And as Mike said, we'll time the other half of Delta 2 according to our plans and how that revenue growth goes. But as we've said before, our revenue plans for this year, we have all the capacity that we need to achieve those targets in Delta 3.5, Delta 2. Okay. Is that good Andrew?

Sorry, I was. Thank you very much for the detailed answer. And maybe moving to a more holistic view, including produce. Wondering if you could give a little bit more color on the outlook here. As you mentioned, Canadian cannabis continues to contribute positively, but it seems to be offset at a very challenging market in the Produce segment. You've been operating in this area for a very long time. And wondering what your thoughts are on when we could see some of these headwinds. And under the scenario where input cost inflation remains sticky for the remainder of the year, how you plan to combat that to return to positive gross margin.

Before discussing specifics about our future in produce, I’d like to step back and provide some context. Since 2016, we've indicated that it was time to transition to the third generation of our crop selection, moving from cut flowers to cannabis. This shift is a significant pivot for Village Farms, driven by changes in regulations and legalization in both domestic and international markets. Our experience in Canada has been incredibly positive, and we believe we have validated our business model as one of the leading examples of effectively converting existing assets, supported by a strong management team, to succeed in both Canada and the international shipping market. This optionality represents a major opportunity for the company moving forward. Two years ago, we anticipated quicker political changes in the U.S. than we’ve seen, which has made it necessary to remain focused on the largest potential cannabis market. While the timing of such changes is uncertain, it’s worth noting the millions being spent by our competitors for similar options, with many facing significant quarterly losses to stay competitive. Although this has been our toughest quarter in the produce line recently, it pales in comparison to what competitors are experiencing amidst these legislative challenges. We’ve long communicated that our aim was to reach breakeven as we wait for legislative changes, and while we’re not stepping away from the produce industry, we will manage that alongside the developing cannabis market. As we strive to achieve breakeven, it’s important to recognize the broader context impacting us. The challenges posed by COVID and the current commodity market, including sharp increases in fertilizer and diesel costs, are factors outside our control. Nevertheless, we will continue to find solutions. Ultimately, as I noted earlier, we are in the process of shifting our assets toward cannabis, which could occur this year or be a couple of years down the line. If you need more details, I’d like to hand it over to Steve for further insights.

Yes, Andrew, we're not projecting or forecasting a positive EBITDA for ROSE until the fourth quarter of this year.

Thank you very much for that color. I will get back in the queue.

Thank you. Your next question comes from Pablo Zuanic, Cantor Fitzgerald. Pablo, please go ahead.

Hi. This is Matthew Baker on for Pablo. Thank you for taking our questions. How would you characterize your performance in flower over the last 12 months in general, but more specifically in terms of your dependence on Pink Kush?

Mandy, do you want to take that?

Yes, we continue to excel in the flower segment, which is the largest portion of our business, and we are confident in our ability to maintain this performance. Pink Kush has been the top-selling strain since cannabis was legalized, currently holding nearly 4% of the national market share, which is remarkable. It has sold over twice the amount of the second-best-selling flower SKU in the industry. This has been a significant success for us. We have always committed to providing consumers with the flower products they desire and that sell well. Pink Kush has seen tremendous success over the last year and is starting to stabilize as new products are introduced. We have also launched Jet Fuel Gelato, which became the top-selling new SKU in Ontario since its debut in October through the first quarter, in terms of kilos sold among all new strains. We are actively developing our pipeline of genetics and strains for Pure Sunfarms and our other brands, as well as through our ROSE partnership. We do not think we are overly dependent on Pink Kush. In fact, we have observed a 20% to 30% increase in market share and total sales for Pink Kush over the past few months. We intend to maintain this momentum, as it is a highly profitable and popular SKU that represents our brand well. However, with our significant cultivation capacity and the new genetics we are testing, we will continue to innovate and offer exceptional products to the Canadian cannabis consumer. We do not believe there is an overreliance on Pink Kush, and we feel well-positioned to be the preferred choice for consumers who keep returning for it.

Thank you for that answer. For our second question, what would you say is a normalized gross margin on a percentage or a per gram basis for your flower business?

Steve?

Depending on the SKU itself, our gross margins for our pure flower, excluding pre-rolls is between 50% and 60% pretty consistently quarter-on-quarter.

All right. And just one last follow-up. How is delisting the stock from the TSX and only having the NASDAQ listing helped you, if in any way? And maybe just remind us of the rationale of the TSX delisting? Thank you.

Well, our short position. I'll start and give it to Steve, a short position. As we monitored since January 1, has come down significantly. Canada has a naked short policy. We didn't like that and we are happy with that decision. Overall long term, we think it will play off. Steve?

Yes. The challenge – we had regulatory issues between the, let's say, NASDAQ is from a regulatory involvement in your business is regulatory light, believe it or not, for the US. And its tax is overbearing and very expensive. So, in the first quarter alone, we saved $200,000 by not being on TSX. Yes, our trading volume is down. There's no question about that, but our short positions, Mike mentioned is down substantially and we're fine with the decision we made.

It was difficult to justify the value proposition while we were paying four times more for TSX compared to NASDAQ since our listing there. We couldn't justify that expense. Our focus is on profitability, which influenced our decision. I believe that in the long run, particularly with the potential for US legalization, this will benefit us.

Thank you. Your next question comes from Rahul Sarugaser, Raymond James. Rahul, please go ahead.

Hey Mike, Steve, Mandesh. Thanks so much as always for taking my question. Mike, you asked a lot of my question around management of the produce business as you balance that against maintaining those assets and providing optionality in the US. I'd just like to drill a little bit further. You mentioned those assets potentially driving about $1 billion in revenue. Could you give us a little more color in terms of how you come to that number? But also, balance that optionality against the incremental cost that you are seeing for maintaining that asset, particularly relative to the current cash position and maintaining cash burn such that you maintain sufficient liquidity through this inflationary time?

Yes. If we consider the size of Texas, while we may not convert everything, the $1 billion estimate reflects that Texas has three times the operational footprint we currently have in Canada, if not more. Given our projections for Canada in 2023, reaching that $1 billion seems quite feasible. Additionally, Texas offers unique opportunities. We view it as a crucial market. Assuming legalization advances, Florida would be a top priority for us, but Texas is where our assets are located. Currently, there’s no competition in Texas, which is the second most populated and rapidly growing state in the U.S. I believe that once the market opens up, it will be a race to establish dominance in Texas, and after three decades of operations there, we see ourselves as a key player. While Texas presents challenges, our investment there is essential for future growth. This year may see the largest cash investment we make, but we are confident that our other businesses will continue generating positive cash flow. We recognize that we need to make investments to maintain our capabilities. Our success in Canada has been largely due to our assets and the talent associated with them, and we are determined to keep that talent. Moreover, the produce segment significantly contributes to our operations. This year, cannabis is expected to surpass produce as the leading revenue source, but produce helps cover many expenses. Our competitors, who are focused solely on cannabis, face many costs that aren’t as visible when looking strictly at cash flow and EBITDA metrics. Without the financial support from produce, we would struggle to sustain our international growth efforts. I believe this clarifies our strategy. It’s frustrating to see our competitors accept substantial losses quarterly while we face criticism for any minor setbacks due to our legacy business, which remains a vital contributor.

All fair points and thanks very much for that color, Mike. So now congratulations on the continued performance of the Canadian cannabis business, and you had talked a little bit about international. Historically, we've not seen international make much of a dent in many of your peers income, but really quite recently, we have seen it start making a material impact. So can you give us a little more color in terms of how you're looking at international revenue playing out for the remainder of 2022?

We have not rushed into international operations except for beginning the EU GMP process. As I mentioned earlier, we targeted the most challenging jurisdictions in the country, particularly in Germany, where EU GMP certification varies in complexity. We have achieved the highest level available, which positions us well. We have taken our time to ensure everything is done correctly. We are the only greenhouse that has reached this level. Based on our pricing and cost structure in Canada, if we apply that to the EU market, we believe we will be well-positioned for exports when we begin. We wanted to establish a strong footing in Canada before expanding into the EU or Israel. We recognize that we still have work to do in Canada, but we are confident in our progress. We plan to begin exporting this year, targeting both Germany and Israel, potentially in the next quarter or by the fourth quarter. With Switzerland launching a record experiment and France starting medicinal cannabis, we are optimistic about our success in the EU and are eager to commence this process.

Thank you. Your next question comes from Doug Cooper, Beacon Securities. Doug, please go ahead.

Hi Doug.

Doug, your line is open.

Sorry about that. I was on mute, sorry about that. Thanks guys. Most of my stuff has been asked already, but maybe just Steve, if you have it or you can disclose it, what was the contribution of ROSE in the quarter of the $21.5 million of cannabis revenue in Canada, how much was ROSE?

We are not running the businesses separately, as Mandesh mentioned. There is biomass exchanged between Pure Sunfarms and ROSE, which is interconnected and a key factor in ROSE's success. Based on the data we have, we consider ourselves the third brand in Quebec. Therefore, it's important to recognize that ROSE and Pure Sunfarms are not entirely distinct operations.

Okay. So, when you say top three producers, how do you quantify that? Is that through sell-through of your own brands or how do you quantify that?

Yes, sell-through.

Okay. And that was in the quarter or that was in March, or what period was that in?

That was in the quarter.

Looking at Canadian cannabis sales in retail, they declined in January compared to December and were also down in February versus January. This might be related to seasonality. Generally, in provinces like Alberta, revenue has remained flat for about a year, with Ontario being the only region showing growth. Mandesh, can you share your thoughts on how, if the market is stagnant, gaining market share becomes essential? Could you also discuss the strategy behind the cookies and other partnerships aimed at increasing share? Additionally, what is the current pricing environment like? Are average prices still decreasing? That's all from me.

Yes, those are good questions, Doug. I'll start with your first point. We have strong confidence in the Canadian market. We believe there's a significant opportunity as we see the shift from illegal sources to legal ones, and we are encouraged by government efforts to eliminate the illicit market. There are still areas in Canada, like parts of British Columbia and Ontario, where retail availability is limited, which we think will contribute to overall growth. Regarding market share gains, everything we've done with the NOYA team and the Cookies launch are efforts aimed at customer segments that Pure Sunfarms hasn't fully targeted yet. We're focused on expanding our product assortment, and we're noticing that throughout the supply chain, whether with provincial boards or retail operators, there's an increasing need for consistency and reliability in supply, product, and pricing to succeed in a rapidly changing market. A highlight for us is that Pure Sunfarms has established itself as a reliable partner in Canadian cannabis. I feel confident when visiting stores and speaking with budtenders about their appreciation for our brands and products. In Quebec, the ROSE team is making notable progress in that market. All these factors enable us to capture more market share. On pricing, we continue to see competitive pressures as others invest in pricing, sometimes to their disadvantage. Despite price reductions, we've improved our branded margins quarter-over-quarter and year-over-year, which speaks to our ability to grow and our expertise in cultivation and manufacturing. We're working on reducing costs and waste, improving efficiency in our product lines. I anticipate some fluctuations in pricing over the next few quarters, which is why we're launching two new cannabis brands to address the everyday premium segments. Pricing will remain competitive, but I'm confident in our ability to compete effectively. I expect we will come out strong with gains in market share and pricing strategies to tackle different areas of the market. I hope that answers your question, Doug.

Yes. Thanks, Mandesh.

Thank you. Your next question comes from Eric Des Lauriers, Craig-Hallum Capital. Eric, please go ahead.

Thank you for taking my question. Could you elaborate or provide some quantifiable details about the rebound you're experiencing, particularly from provincial buyers from late Q1 into Q2 or from the spot wholesale market? It would be helpful to know how these trends have been changing from late Q1 into Q2. Thank you.

Sure. Mandy, take that question.

Yes, you cut out there slightly the starting Eric. Are you asking about volume or pricing, sorry, can you just repeat that?

Just overall, looking just to get a bit more color on some of the dynamics in wholesale and then from provincial buyers. You guys mentioned, obviously, that's sort of seasonally weak first part of Q1, and that's rebounded nicely at the end of the quarter and just looking for some color on how that's continued into Q2? And if you're able to quantify it all, that would be great.

I will begin with the wholesale B2B non-branded aspect and then return to discuss the provincial side. As Doug pointed out in his question regarding industry sales, they tend to fluctuate from month to month, and I believe we are entering a cyclical pattern quarter over quarter. Typically, as we move into summer, sales tend to rise as social activities increase, but during the colder months, we usually observe a decline in sales. We see similar trends in the non-branded wholesale segment. When sales are increasing and markets or provinces are expanding, our communication with customers is very active. During other months, we maintain a steady base of licensed producers and suppliers who receive high-quality inputs for their products. This fluctuation occurs throughout the year, and we will always seek out opportunities. Our extensive cultivation capacity allows us to explore various revenue channels as opportunities arise. Our collaboration with the NOYA team and the introduction of additional brands is focused on maximizing margins from our biomass. We have patiently managed one brand under Pure Sunfarms while developing a significant range of genetic materials, both sourced and proprietary, that are unique to us. We are now positioned to launch these genetics in the market through Pure Sunfarms and our two new brands, along with increased pre-roll capacity and other products. You'll likely see a greater portion of our business transition to the branded segment. This insight illustrates our approach to wholesale; we will always remain active and pursue opportunities, but our strategy has consistently been to shift some biomass toward higher-margin offerings in our brands. Regarding the retail dynamics and provincial purchasing behaviors, I mentioned earlier that we will continue to observe fluctuations. Every March, many boards review their inventory and manage what they have in their distribution centers. The listing process has been efficient, and we are pleased with the ongoing products that are being listed across the country, not just in Quebec, thanks to the efforts of the ROSE team and the returns from our financial partners who seek reliable suppliers and licensed producers. There is a continuous assessment of sales forecasts and product offerings, and we are still in the early stages of this market. Therefore, maintaining a strong relationship with the board is advantageous as they are still navigating various dynamics. You can expect ongoing fluctuations quarter by quarter in terms of sell-in and sell-through. However, we are confident in the trajectory of our revenue and market share growth in the Canadian cannabis sector this year.

All right. Very helpful. I appreciate that color. Last one for me. Just on the produce side. Just wondering if you guys could expand a bit more on your ability to conserve costs, maybe kind of split it out between variable and fixed. And I'm assuming that sort of the ability to maybe mothball one of the facilities you guys have in Texas. I'm assuming something like that is sort of out of the question, just given the labor there and whatnot and the sort of cost of restarting or whatnot. But could you just perhaps give us a bit more of an understanding of sort of the levers that you guys have to pull to conserve costs there? And just overall, how we should kind of think about those costs, essentially. Thank you.

Sure. The business operates primarily on fixed costs, with 90% of our expenses being fixed. We are aware of our input costs in advance, and those are set. The only variable expense relates to the amount we pick, such as needing more boxes and freight, but that component represents a very small portion of our overall costs. Managing these fixed costs can limit our options. Regarding cost-cutting, we have various profitable products. For instance, we hold an exclusive product in North America that performs well, as does another one for which we share semi-exclusivity with two other companies. However, we face challenges similar to a whack-a-mole scenario: if we focus on the most commoditized product, which is the top seller for retailers, we need to ensure efficiency in our shipments, as we can’t simply send small quantities across the country. We must find ways to increase that lower-cost commodity, even if it results in losses, to maintain freight efficiency. Additionally, retailers are unlikely to purchase our other profitable products if we don’t have the commodities they require. A good example of this would be our legacy products like Vino Divino, which are historical commodities yet have the highest sales volumes. In terms of facility shutdowns, we are considering this, but it won’t involve entirely closing a separate facility; we might scale down operations in one facility to keep our key management team in place. We already shut down one operation in the Permian Basin last year but resumed production after COVID, and we may consider doing that again. Furthermore, we are engaging in discussions with some competitors to collaborate on marketing efforts to cut costs and enhance fulfillment efficiency.

That's very helpful. Thank you, Mike.

Thank you. Your next question comes from Scott Fortune, ROTH Capital Partners. Scott, please go ahead.

Hey, good morning. You have Nick on for Scott here. Just first question around the derivative side, it looks like the derivatives segment in Canada was off sequentially as a percent of sales. Could you just provide a little color around your growth strategy within that category and what you've seen in terms of pricing and end market demand within that segment? Thank you.

What was the product you were talking about, Scott, because you have a lot of background noise?

Sorry, the 2.0, the derivatives segment within Canada, just it was off sequentially as the percentage...

Sure. Okay. Mandesh, why don't you take that call on Q4?

Absolutely. Good question. So derivatives, meaning vapes, edibles, any of those extracted products. So, I think when you look at that space, for sure, vapes are the number two, three category in sales in almost every jurisdiction. It's a very important part of the sales trajectory. And we're going to continue to put new products. We launched a new Mint in few CBD Red Penn. We have some other high THC vapes coming to the market. And it's an important part that we're going to continue to innovate, being where the consumer wants us to be at the price point, staying with edibles, continuing to expand the portfolio and look at various formats and flavor profiles. When I take a step back of 2.0, and we talked about the word commoditization, it's one of the words that I think about the most when I think about the 2.0 space. And Steve alluded earlier on our flower margins and how high and strongly, are which is the largest part of the market. So derivatives, is an important part of the market. We'll continue to innovate and be there for the consumer and make sure we're offering the right assortment strategy for our Pure Sunfarms brand as well as our two new brands on THC that we're going to launch. But it's a highly commoditized space. I mean, the main input distillate is a commodity in a true sense. And I think, we're going to continue to see massive price reduction – a lot of people who are going – to lower grade biomass into extracted products. And when I look at some of our competition and the money they're losing, it's clear that – that's the bet they've made on the 2.0 space. So I think that's the way we look at the through the space, an important part to be in. We're definitely going to be flower first. But we're not going to lose focus on how we innovate and understand what the key trends are and where our product assortment needs to be in that space.

Got it. I appreciate that color. And then a follow-up for me on the US CBD side, it looks like Balanced Health was slightly off quarter-over-quarter in terms of revenue, but still profitable. Can you just provide an update on your growth strategy there within US CBD and how you're looking at potential M&A versus new SKU introductions, retail expansions, et cetera, to drive that growth? Thank you.

Well, we're pleased with their performance. That is, we have a multipronged strategy for high THC in the US and Balanced Health is the centerpiece for that, as an incredible team, and we're going to utilize that organization to go much further in high THC when we can. That's aligned on a parallel track with our plans in Texas as a cultivator, as well as other maybe M&A opportunities at that point. But for looking at the CBD, pure-play CBD in the US for M&A, I can tell you that, we all look at that on an ongoing basis, and there's nothing resonating. No one is making profit except, so we can tell publicly traded BHP, kudos to that team for constantly doing that. Their margins are exceptional, which means, if we see erosion in the quarter on revenue in light of the current economic times, I mean, CBD and cannabinoid products are important, but they're not eggs and milk. That may happen over the course of this inflationary period. That said, we're pretty pleased but yeah, we would look at opportunities to expand that. It's just that we love accretive deals, and we don't like to take on other people's mess just to shut them down, which seems to be a big play in the M&A space. So we're going to be patient there. Right now, cash is king. And when we utilize our capital, we want to be very prudent and very sure we're going to win here, and it's going to be accretive. We have to compare those current opportunities in the current US market to the international opportunities as well.

Got it. I appreciate the color.

All right. Well, thank you, operator, and thanks for everybody hanging in this long. We appreciate everyone hanging on the phone. And we look forward to reporting on our next quarter.

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.