Earnings Call Transcript
Village Farms International, Inc. (VFF)
Earnings Call Transcript - VFF Q4 2022
Operator, Operator
Good morning, ladies and gentlemen. Welcome to Village Farms International's Fourth Quarter and Year-end 2022 Financial Results Conference Call. This morning, Village Farms issued a news release reporting its financial results for the third quarter ended December 31, 2022. That news release, along with the company's financial statements are available on the company's website at villagefarms.com under the Investors heading. Please note that today's call is being broadcast live over the Internet and will be archived for replay, both by telephone and via the Internet beginning approximately one hour following completion of the call. Details on how to access replays are available in today's news release. Before we begin, let me remind you that forward-looking statements may be made today during or after the formal part of this conference call. Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements. A summary of these underlying assumptions, risks and uncertainties is contained in the company's various securities filings with the SEC and Canadian Regulators, including its Form 10-K MD&A for the year ended December 31, 2022, which will be available on EDGAR. These forward-looking statements are made as of today's date and except as required by applicable securities law, we undertake no obligation to publicly update or revise any such statements. I would now like to turn the call over to Michael DeGiglio, Chief Executive Officer of Village Farms International. Please go ahead, Mr. DeGiglio.
Michael DeGiglio, CEO
Thank you, Chris. Good morning. And thank you for joining us today. With me are Village Farms' Chief Financial Officer, Steve Ruffini; Village Farms Head of Canadian Cannabis, Mandesh Dosanjh; and Village Farms Executive Vice President of Corporate Affairs, Ann Gillin Lefever. As for our usual, Steve and I will review the operating highlights and financial results for the quarter, and then we will be available for questions. Let me first begin with the key takeaways for our fourth quarter. First, our Canadian cannabis business now ranks number two nationally and market share after steady growth throughout the year. In fact, our retail branded sales grew 25% year-over-year, while the market grew just over 13%. That's nearly twice of that market. We launched multiple brands, notably the original Fraser Valley Weed Company, Soar, and Promenade, and we generated 17 consecutive quarters of positive adjusted EBITDA. Importantly, we grew while integrating Rose Life Sciences into our platform. Many times in the past we were asked about getting access to the Quebec market, we did. When we acquired Rose in very late 2021, it ranked 12th in terms of Quebec market share; now it ranks second. This is a great achievement in just one year. Just after the quarter, we further expanded our export markets with our first shipment to Israel and expect additional shipments to other countries in short order. Second, in the U.S. cannabis business, Synergy+ is on track to be a $4 million a year brand in retail in less than one year since launch. Another outstanding achievement. And once again in Q4, the team's performance has made Balanced Health one of the very few positive EBITDA CBD companies that we know of. Third, Fresh Produce is turning around. 2022 was one of the most difficult years of my long career in the produce business. In fact, the Brown Rugose virus has cost us $13 million over the ‘21 and ‘22 crop cycle in Texas alone. And that's only in production costs and yield. It does not include the impact on customer relationships, and it does not include the impact of the virus in the calendar year 2022 in our Canadian facility, which we had not previously experienced. A significant turnaround for Fresh Produce is on the horizon for 2023, which we will demonstrate in the first quarter of 2023, much of this being driven by encouraging success with the Brown Rugose protocols. Q4 demonstrated the strength of our strategy, including surgical investments, operational improvements, including AI technology and innovations we made, which resulted in the year ending on a much stronger footing than it started in Fresh. With respect to Canadian cannabis, we have read all the same news articles and hear the same pundits that say Canadian cannabis is out of favor with investors. Actually, all cannabis in North America is out of favor with investors. Despite this, we are, with all of our current challenges, we have worked hard, demonstrated operational excellence, and have proven our business and built an enviable position. What other consumer products industry does this kind of growth exist for an industry leader? I don't know of one, and who can claim our depth of experience to capture future growth in the industry? It will get better, and when it does, we will have a clearer leadership position. Let me spend a few minutes clarifying our strategy. When we expanded into cannabis, we expected the sequence to be: one, launch in markets where our cultivation expertise would be the basis for a competitive and profitable business model. We chose Canada. Two, maintain optionality to enter the U.S. market, which as the number one single country market for cannabis, is a huge opportunity. We assigned a value to the very real optionality about Texas's space assets as worth much more, assuming produce broke even than starting from scratch in the U.S. where legally permissible, as we have done in Canada. Which brings me to the last event in the sequence: number three, when the U.S. market legally permits us, in our case to enter it, which is permissible by NASDAQ and with a strong preference to convert some of our Texas space assets as we have done and proven in Canada. So how is this working out? On number one, as you can see, our results in 2022, despite very difficult market and regulatory conditions in Canada, which have impacted all players' profitability, we have built a very competitive and profitable business model. I give us a solid A grade for our efforts, especially when the vast majority of what we have built, we have built organically, not through M&A. Number two has proven more difficult in 2022. In simple terms, the options to enter the U.S. market ended up costing more than expected due to factors I have discussed for the last three quarters. 2022 hurt the option value, so I'd give us a D for this part of the strategy last year. Number three, our original expectations were that restrictions would be addressed by Washington and the legislative actions in 2022, at least after the midterms, at the latest, which we extended later on to the lame duck session ending in January of this year. You probably guessed that I would assign an F to the efforts in Washington. But I'd also give us a C, as it's our job to manage in a regulated market as well; we would never run a business the way Washington itself. We recognize it to improve our average. To do so, we are attacking all assumptions about entering the U.S. market, starting with the need to improve and de-risk Fresh business results. We have undertaken the following: we will be reducing the footprint of our Texas assets to improve profitability and focus on cultivation assets and teams in one region in Texas to better service our profitable customers. We have identified and started implementing multiple operational improvements, which will enhance yields and lower costs. We're reviewing every relationship focused on those accounts which are most profitable for us, so that we can over-deliver to key customers. Regarding factors out of our control, climate, virus, inflation, I'm sure you can appreciate that operators only discuss these when they are putting pressure on the business model, but they are very real across all agricultural businesses. Over our 30-year history and experience dealing with these factors is one reason we have built the top cannabis cultivation operation in the world. As of the first few months of 2023, inflation and the Brown Rugose virus, which put tremendous pressure on our profitability in 2022, are abating. I'm not ready to call victory yet, but I will call on those in our Fresh business who have been attacked by the virus input costs and pricing opportunities. They have made me cautiously optimistic. So to summarize, we have launched a plan to de-risk Fresh operations by attacking the asset base costs and consumer customer profitability. Our goal is to keep attacking these fronts until we can safely deliver a positive EBITDA contribution, absent any major climate or economic event. We understand that as a business, Fresh must contribute to the growth of Village Farms. I will turn it over to Steve for a more detailed review of the financials. Steve?
Stephen Ruffini, CFO
Thank you, Mike. Before discussing the results, I want to highlight the effect of acquiring 70% of Rose Life Science on November 15, 2021. As a result, the fourth quarter and annual 2021 results only include six weeks of contribution compared to last year's figures. For the fourth quarter, consolidated sales for Village Farms reached $69.5 million, a decline of 5% from the same quarter last year, largely due to a weaker Canadian dollar in 2022 compared to 2021. When accounting for constant currency, our year-on-year sales were nearly unchanged, down by just 1%. Sales from our Canadian cannabis sector increased, but were balanced out by declines in Fresh Produce sales. On a constant currency basis, cannabis sales accounted for about 50% of our consolidated results in U.S. dollars. The consolidated net loss for the quarter was $49.3 million or $0.41 per share, in comparison to a net income of $2 million or $0.02 per share from the same period last year. Our Q4 2022 net loss included significant non-operational charges due to adjustments on our balance sheet, including an additional $13.5 million impairment of goodwill related to the valuation of the acquisition of Balanced Health Botanicals, in addition to a $29.8 million impairment charge from June 30, 2022, linked to the sharp decline in valuations of other publicly traded CBD companies. The cumulative impairment of $43.3 million for the year was a major factor in our reported statutory full-year loss of $101.1 million. We also recorded an $11 million U.S. charge, or $15 million in Canadian dollars, for aged lower potency flower inventory in our Canadian cannabis business. Additionally, we adjusted our U.S. deferred tax asset with a substantial change in our 2022 tax provision, leading to a $19.2 million charge to earnings for the quarter. These balance sheet adjustments accounted for $43.7 million of our reported $49.3 million loss. The consolidated adjusted EBITDA for Q4 2022 was nearly breakeven at a loss of $756,000, compared to a positive adjusted EBITDA of $5.1 million in Q4 of 2021. The EBITDA loss this quarter was driven by Fresh Produce, although we did see considerable improvement compared to Q3. Corporate costs remained relatively flat year-on-year. Moving to Canadian cannabis results, I will report in Canadian dollars for better accuracy concerning our performance amid exchange rate fluctuations. Our Canadian cannabis operations achieved year-on-year growth of 13% in Q4, totaling CAD 38.2 million. Retail branded sales for Q4 significantly outperformed market growth, increasing by 25% year-over-year. Conversely, wholesale sales for Q4 dropped 35% year-over-year due to ongoing price erosion as distressed producers sold off inventories. This revenue stream can fluctuate greatly from quarter to quarter, particularly in Q4. The wholesale pricing situation prompted us to write down CAD 15 million of aged and lower potency flower inventory, based on its expected realizable value against current wholesale market prices. As we sell this inventory, it will exert pressure on our gross margin target range of 30% to 40%. Excluding this write down, our gross margin for Canadian cannabis in Q4 would have been 40%, at the high end of our stated target range, up from Q2 and Q3 as we strive to deliver high-quality, well-priced products. Selling general and administrative expenses for our Canadian cannabis operations in Q4 amounted to CAD 9.8 million, or 26% of net sales, compared to CAD 9.2 million or 27% of net sales in Q4 2021, reflecting sequential improvement following our investments at the end of 2021 and during the first half of 2022. We are aiming to bring SG&A as a proportion of sales back to the lower 20% range in 2023. The Q4 2022 SG&A included severance costs related to our publicly announced headcount reduction in early Q4. Our Canadian cannabis operations achieved their 17th consecutive quarter of positive adjusted EBITDA, reporting CAD 6.3 million, an increase from CAD 6.1 million in Q4 2021. Now, turning to our U.S. cannabis operations, I will switch back to U.S. dollars. U.S. cannabis sales for the fourth quarter, solely generated by Balanced Health, totaled $5.3 million with a gross margin of 67%. This is a decrease from $7.5 million and a gross margin of 71% in Q4 last year, primarily due to challenges faced across the industry, though we believe we are outperforming most of our peers. Our results in the later half of 2022 were partly influenced by the success of our Synergy Plus line of hemp-derived THC products. Adjusted EBITDA for U.S. cannabis was $300,000, down from $1.7 million in Q4 of 2021. Regarding Fresh Produce, although financial performance was still affected by inflationary pressures, particularly in freight and other production costs, as well as volume losses due to the Brown Rugose virus, we saw significant quarter-on-quarter improvements mainly from our Texas operations, which have continued into early Q1 2023. Adjusted EBITDA was negative $3 million, compared to a positive $700,000 in Q4 of 2021, indicating a significant sequential improvement from the negative $4.9 million we reported in Q3. As expected, our results demonstrated a significant contrast between the first and second halves of the year, with adjusted EBITDA for the latter half improving from a negative $16.5 million to negative $7.9 million in the first six months of 2022. Moving on to cash flows and the balance sheet as of December 31, 2022, we held $16.7 million in cash and roughly $44.1 million in working capital. During the quarter, we experienced a net cash outflow of $1.5 million after accounting for all operational capital expenditures and financing activities. Following the end of the quarter, Village Farms Management, our Board, and our advisors decided to raise $25 million through a registered direct offering of about 18.4 million common shares at $1.35 each, along with warrants to purchase an equal number of shares, which at an exercise price of $1.65 would yield an additional $30 million. This decision was made based on our assessment of factors outside our control for 2023, as well as a failed federal cannabis legislative agenda that may have provided more effective capital market fundraising opportunities. We felt it was our responsibility to our shareholders and all stakeholders to strengthen our balance sheet to allow us to focus on executing our operational plan without distraction. Now, I’ll turn it back over to Mike.
Michael DeGiglio, CEO
Thanks, Steve. There are a couple of insights with respect to the 2023 start that I would like to close with. First, as you know, we are always evaluating competitive dynamics, innovation, and consumer demand preferences. In our current assessment, the Canadian cannabis team is comfortable implementing a price increase on select products, which have been communicated in market. This is what a market leader should do. And I know the team will monitor the impact through this initiative. If successful, our leadership in this regard could be a positive inflection point for the industry. Second, as an industry leader, we have an obligation to share our expertise and insights with all of our stakeholders. Recently, senior Pure Sunfarms Management participated in a series of meetings with members of the Canadian government. Our message is shared by other LP operators: excessive excise taxation is contrary to the government's own promise to Canadians to keep taxes on cannabis low to support the objectives of legalization, which are keeping cannabis out of the hands of youth and profits out of the hands of criminals, as a key legislative initiative was the availability of a safe regulated product. Yet, even with the legal market approaching $5 billion, the illicit market is still estimated to be 40% of consumption, due largely to the huge tax-driven price differential. Mission-critical investments in the industry's businesses, employees, and our communities are very much at risk. The appropriate model of taxation exists in other consumable products industry; we support all efforts to revise excise taxation levels immediately. And with that, operator, we'll open up to questions. Thank you.
Operator, Operator
Our first question will come from Aaron Grey of Alliance Global Partners. Your line is open.
Aaron Grey, Analyst
Hi, good morning. And thank you for the questions. Hey, how's it going? So first question for me just want to get a little bit more color in terms of some of the price increases that you indicated on select products, any more color that you could provide? And maybe on what products or brands? And then how much are you willing to potentially cede some share in order to improve the profits and then margin on that? And then what gave you the comfort to maybe implement from those price increases now just given the market is still rather fragmented and still seeing a lot of pricing pressure? So maybe you guys aren’t deleting brand, but maybe some others not following you do see some share? What kind of gave you the comfort to that now versus waiting for someone returning to the market? Thank you.
Michael DeGiglio, CEO
Well, thanks, Aaron. Before I turn it over to Mandesh, that was one of the last time that became your first question. So I just think, Mandesh, do you want to give some color on that?
Mandesh Dosanjh, Head of Canadian Cannabis
Yes, absolutely, that's a good question. We're not going to provide extensive details since we have examined a lot from a competitive perspective, but I will address some of your main points. First, regarding market share, our focus isn't on giving up share to enhance margins. We have a solid understanding of consumer behavior, the factors driving demand, and we continuously analyze pricing to identify opportunities. We're always evaluating the situation. Currently, we see an opportunity to increase margins without affecting our market share. Our strategy is centered on achieving profitable market share and improving market dynamics. We recognize and are acting on opportunities across several key brands where demand exceeds supply, refining our pricing strategies in various regions as market conditions evolve. We feel confident because of the strength of our brand, the consistency and quality of our products, and our competitive position in the market. A strong consumer packaged goods company with solid pricing analytics will always take the opportunity to refine their approach when the timing seems right, and we believe that timing is now for us.
Aaron Grey, Analyst
Thank you for that information; I really appreciate it. Regarding the distressed sales of biomass you mentioned, can you share your thoughts on how this might develop in 2023? It appears there's a significant amount of inventory available. How do you anticipate the lingering impact of this? Are you confident in how you are utilizing Fraser Valley to compete in that value segment? I would like to understand the broader market better, especially concerning more distressed sales and any potential effects. Thank you.
Michael DeGiglio, CEO
Mandesh?
Mandesh Dosanjh, Head of Canadian Cannabis
Yes, maybe I'll take it in a bit of a reverse order there, Aaron. So your second part was around Fraser Valley. We launched Fraser Valley last year to compete in the value space of flowers, an emerging space where Pure Sunfarms was carving out a really solid niche and continues to. We felt like we were under indexed or not represented while in value, and Fraser Valley did that. And it's taking a leading market share position one, two, three, in every market that it competes in, with a very, very limited assortment, being led by Donnie Berger, a strain that's wildly popular across the country. So in that brand, we think there's still a lot of opportunity. We see that segment growing as we thought it would, as inflationary pressures with consumers and then tough economic times happen across the country. So we love Fraser Valley; it's doing extremely well. It's growing a significant amount of market share for us. And we think the ability to continue to leverage and play in Fraser Valley and take more profitable market share is definitely part of our strategy this year, with some more innovative, exciting things happening within Fraser Valley. Dovetailing that into the first part of your question, which was, will it allow us to be a source for extra inventory or inventory where we might have gotten our supply chain and forecasting incorrect and be long on some inventory? Absolutely. Fraser Valley is meant to be a value-based SKU; it gives us consumers great affordability and great offerings and will definitely leverage it. So it is an outlet for us on inventory that we’re long on. And then yes, Aaron, I think you're absolutely right. I mean, people are selling and being desperate out there. And we see kinds of spot prices in the B2B market all over the board. And it's just not sustainable. We have a good bevy of customers that we deal with on the domestic B2B side. And it’s actually allowed us to simplify; customers who want to buy consistent products that are available that’s consistently grown with great quality, I mean, they're coming to us. And that’s what we like dealing with. So, we do see a lot of irregularity on the spot market. It’s kind of feast or famine; we see a lot of inbound calls come as pricing or things dry out there. And I just don't think it's sustainable. And then people are going to be desperate. I'm not sure, Mike, if you want to add any more color on the desperation of other producers or what's happening there.
Michael DeGiglio, CEO
Yes, we are really focused on the retail side, and you can see it in the numbers, which show a 25% year-over-year increase. However, as Mandy mentioned, it's not sustainable in the long term. We have a solid understanding of our costs and what other producers are charging, and the current prices are not sustainable. This situation may continue through 2023 and possibly into 2024, but it's hard to predict. Since it's a perishable product, its value will eventually diminish, and we will remain patient. That's the situation as it stands. Thank you.
Operator, Operator
Thank you. Our next question will come from Frederico Gomes of ATB Capital Markets; your line is open.
Frederico Gomes, Analyst
Good morning. Thanks for taking my questions. My first question is on the divestment of your facility in Texas. How long do you think that that sales process will take and how much do you expect to sell it for, any color on that front? Thank you.
Michael DeGiglio, CEO
Yes, we're not going to comment on what we expect today for that asset; we don't think it'll take too long. Probably, the process has started, so probably four to six months is what I would guess. It's a great asset. As I mentioned on the call, where we are out, the majority of our Texas assets are in one location, which is just the most ideal location, we believe in the United States or one of the top three. And we have a large footprint there, and it’s an expandable footprint. That's where most of our management team is. The Permian Basin is sort of out there on its own. So we want to focus our whole team on that larger footprint. But, I think for Texas, when you really look at the ability to have an asset in Texas, as big as Texas, it is an asset like this, it's very limited where those assets can be, so we think it's a very valuable asset and that we're optimistic that the process will move fairly quickly, Frederico.
Frederico Gomes, Analyst
Okay, thanks for the color. And then my other question is on the Canadian cannabis side; most of your exposure right now obviously remains in flower. But could you provide some more details on the initiatives that you have in place for other categories, I think especially pre-rolls? Do you expect any uptick in sales from that category this year, any new products, investments in automation, etc.? Can you talk about that?
Michael DeGiglio, CEO
I'll hand it over to Mandesh for additional insights. To begin with, I want to emphasize that we view pre-rolls as part of raw flower in our internal classification, and it is definitely a growing market. Recently, we made a substantial capital investment in pre-rolls, demonstrating our commitment to succeed in this market. Mandy, could you provide more details on that?
Mandesh Dosanjh, Head of Canadian Cannabis
Thanks for the question, Mike. To build on your point, we have increased our capital expenditure to enhance our pre-roll capacity. Pre-rolls are a significant aspect of our strategy, as we observe a shift in consumer preferences from whole flower to more convenient pre-rolls. We are actively reviewing our product assortment and launching new SKUs that align with our latest strain offerings, while also exploring new strains that are not yet available in pre-roll form. This focus extends beyond Pure Sunfarms to our Fraser Valley offerings and our premium cannabis line, with plans for future developments in Fraser Valley. The pre-roll category presents a substantial opportunity for us, and you can expect to see more innovation and additional listings in this space. We are also refreshing our main line of vapes and expanding our portfolio with exciting new products. The infused pre-roll category is gaining traction among consumers in key markets. Our priority is to approach SKUs the right way, ensuring we grow market share sustainably and profitably. While we might not always be the first to enter a new segment, we are committed to executing our strategy correctly. There is much more in store as we continue to seek out new opportunities, which will be integral to our strategy beyond 2023.
Frederico Gomes, Analyst
Thanks for that. I’ll back in the queue. Thank you.
Michael DeGiglio, CEO
Thanks, Frederico.
Operator, Operator
Our next question will come from Scott Fortune of ROTH MKM; your line is open.
Unidentified Analyst, Analyst
Hey, good morning. This is Nick on for Scott. Good morning, guys. Wondering if you could just provide a little color on mix specifically within the flower category, kind of between the premium mainstream and value segments. And just kind of how you expect that to evolve as some of these new product launches take hold? Thank you.
Michael DeGiglio, CEO
Mandesh?
Mandesh Dosanjh, Head of Canadian Cannabis
Sorry, I was just on mute there. Thank you. Last year, when we launched Fraser Valley, we were really talking to this group, the analysts group, and kind of in market of that real clear separation in value, core and premium. We are starting to see a bit more of that shift into the value, but the core is still there, and premium being, you know, 15% or so 20% of the full flower offering. So, 15% to 20% of any kind of category in premium, you see the bulk of those sales kind of 40%, 50% in core, and then another 20%, 30% in value. And so, kind of that's how it's shaking out in certain regions, whether it's Alberta, British Columbia, or Ontario, might be slightly over or under indexed. And now we're squarely positioned with three great brands in each of those segments; value being Fraser Valley, Weed Company, Pure Sunfarms playing in core, and our store cannabis in Premium. What we're seeing and our expectation for the year is growth in all three, and we're not seeing cannibalization across that; I think that's a key piece. So as we saw with the launch of Fraser Valley, we’re getting again, profitable, meaningful market share without impacting our core Pure Sunfarms offering. So I think that's the key for us as we took our time to launch these three brands, the two other brands that will exist alongside Pure Sunfarms. We wanted to do it in a meaningful way that had differentiation and that grew market share. So we're seeing that, and the plan this year is to grow. And again, in the Premium market for Soar cannabis, I mean, it's a much smaller market; the bulk of our growth rule will really come at Pure Sunfarms being the biggest brand, and then Fraser Valley being the second biggest. So those will be the two main drivers of growth. But we're excited about what Soar has done and already been able to take kind of a 1% to 2% share of flower in the markets that it's operating.
Unidentified Analyst, Analyst
Got it. I appreciate that color. And then just a second for me on the international side. You mentioned solid growth in Australia, commencement of sales in Israel. Just wondering if you had any commentary on the newer markets. I know you're one of the few in the Dutch market, and it looks like Spain looking to ramp capacity. Just any opportunities out there internationally that you're kind of looking at or evaluating, just some color, that would be helpful? Thank you.
Michael DeGiglio, CEO
Yes, Australia has ramped up considerably. We're very pleased with the results in Australia and looking at New Zealand as well. On the European side, it's just been a long process to really get into Germany. We're ready to go, we finally got our permits last week, and it's really to hold up more on the Canadian side. Sometimes it can take 30 to 60 days, and I want to elaborate much on it. But it's crazy, but that should be forthcoming. Israel has gone very well for its shipment. We're actually in pharmacies right now. We've seen pictures of consumers that are happy, so we're excited to see where that can ramp up. And then the UK, we're going to ramp up in the UK very quickly. That's all that work has been done there. So we hope to announce something there in the coming months. And then yes, there's an array of companies in the EU, we kind of not looking at the EU as a whole but surgically looking at different countries because they're all somewhat different. Our plan is to be in all those countries as well, looking forward in ‘23, ’24. As far as the Netherlands? We're still focused on the Netherlands as you know; all the export out of Canada's for medicinal purposes. You cannot export recreational, even though a lot of the strains are the same. The Netherlands, being the first recreational market, the true first large recreational market cultivation will be in country there. As you know, we're one of the 10 license holders, so we hope to start ramping up that facility this year and looking at generating revenues in ’24.
Unidentified Analyst, Analyst
Got it. That's it for me. I appreciate the color.
Operator, Operator
Thank you. Please. Our next question will come from Eric Des Lauriers of Craig-Hallum Capital Group; your line is open.
Eric Des Lauriers, Analyst
Good morning. Thank you for taking my questions. I was hoping to just get a bit more information on the divestiture of the Texas asset, because you just help us understand maybe the financial impact that you're expecting to have on your overall costs in the Produce business? Or if you don't want to give that sort of detailed information, maybe just remind us what percentage of that Texas footprint this facility was. And just maybe your overall thoughts kind of going forward with respect to this divestiture? Thanks.
Stephen Ruffini, CFO
The facility covers 30 acres, but we are currently utilizing only 10 acres according to consumer and retailer demands. This means we are using only a third of the greenhouse, which is not our most efficient operation in Texas right now. We have made a decision regarding our crops; specifically, we are one of three licensed growers of a particular crop in North America, though I won’t specify what it is. The seed company has indicated they are unlikely to pursue resistance development for that crop, which raises doubts about our future involvement with it, as that was the primary crop grown at this facility. However, we do have the potential to expand operations at our other locations, where we have over 100 acres available. I won't be providing additional details on this today.
Eric Des Lauriers, Analyst
Okay. Could you perhaps help us understand which will have a greater cost impact on the Produce business, this divestiture or some of those technology and innovations that you guys are implementing?
Michael DeGiglio, CEO
Yes, we are gaining insights into AI within our expanding system, and it has shown promising results. We dedicated about a year to one of our facilities, and we are now rolling it out to all facilities in Texas, with plans to consider Canada. My earlier comments focused on examining the U.S. market. Looking at our success in Canada, we successfully converted existing assets used for produce into cannabis operations, likely better than others. Constructing a new facility from scratch entails significant capital expenditures and can take three to five years to reach full operational capacity. The Canadian market has experienced substantial challenges for many newcomers and those with new assets; achieving operational excellence requires considerable effort, including training staff and managing turnover, while understanding necessary tools and the climate. Having an existing facility with reliable climatological data and a well-informed team throughout the organization accelerates the ramp-up process and enables organic growth. Thus, when considering our assets in Texas, we anticipate that interstate commerce will be feasible, and the current U.S. model represents an experimental phase that will shift with comprehensive legalization, positioning us advantageously for scalability, cost-efficiency, and quality. This is why we've maintained flexibility, not only in Texas but also within the broader U.S. market. The cannabis asset we considered converting is likely the last one we would pursue as it lies outside our main asset hub, prompting our decision to downsize this asset. Looking ahead, cost savings will be driven partly by the development of virus resistance in our varieties. Although some resistance exists now, I expect comprehensive resistance in tomato varieties by 2025, resolving global challenges for tomato growers. In the interim, we have established protocols. We initially thought we had options for converting specific assets in Texas, which caused us to allocate a large portion of our capital to those projects, converting those costs into sunk costs for cannabis. We have since adjusted our strategy due to uncertainty surrounding federal legalization in Texas, refocusing on our yields, operational excellence, and customer evaluations. We believe these factors will contribute to positive results for Fresh, while also considering alternative crops. As a controlled environmental agricultural company, we are equipped to thrive in various crop types.
Eric Des Lauriers, Analyst
That's helpful. Appreciate that color. Last one for me here. Just wondering if you can talk about the impact that implementing dry hanging has had on your overall various different brands? And then I guess, specifically on cost as well. I mean, I was surprised to see Canadian cannabis normalized gross margins expand to 40% in the quarter. I would have thought that dry hang would have perhaps had a negative impact on cost there. But could you just kind of talk a bit more about the overall implementation of the dry hang now? Or we could perhaps go into see more of that inventory in ’23 and we'll see that drag there, or are you just seeing strong sell-through with that sort of differentiated product here? Thanks.
Michael DeGiglio, CEO
Yes, Mandesh, do you want to answer that?
Mandesh Dosanjh, Head of Canadian Cannabis
Yes. So yes, the hang dried process, we rolled out in totality across the entire operation, spring, summer, last year. So at this point, I mean, all of our inventory that's been hitting the market over the last least quarter or two has been hang dried. And we have seen, obviously, significant consumer feedback; we've kind of did it in a very humble, low-approach way and not really kind of publicizing it until it's fully there, and then really let the consumers in behind the scenes through our digital channels, social media, kind of just letting people get sneak peeks and consumers and bud tenders and store owners across the country have been wow, and seeing that across our entire portfolio from Fraser Valley, Weed Co., and Pure Sunfarms, as well as Soar. It's been remarkable, especially as we put in different strain offerings and just really improve that overall bag appeal. And we're definitely seeing that market, and we're grateful for that. On the cost side, yes, I mean, I think that was one of the reasons why we did this initiative, and it took us a little bit to figure it out. But we kind of, at some level, are cost-neutral. It was really about total cost of ownership. When you're running a facility like we are, there's a lot of different pieces prior to hang drying, which we were doing on shag drying, where we’re drying on trays. So a lot of cleaning, there's a lot of kind of moving parts that you have to maintain. So when you go to hang dry, yes, you're spending more labor and time to get the plant set up that way. But we really implemented a process carefully, where we actually were neutral and even in some areas improved our labor efficiencies. And that's the other part of our nature; we’re always going to be looking at ways to improve our cost structure and margin profile. So I think you're seeing a bit of both: you're seeing kind of the move to hang dry not causing us to increase costs. And then our continuing ongoing commitment and experience in controlled environmental agriculture and operations just driving further efficiency in the operations to make sure our margins continue to be strong and one of the best, if not the best, in the industry.
Eric Des Lauriers, Analyst
That's great to hear. Great execution. And thanks again for taking my questions.
Operator, Operator
Our next question will come from Pablo Zuanic of Cantor Fitzgerald; your line is open.
Pablo Zuanic, Analyst
Look, the first question regarding the announcement by the OCS about adjusting their margin structure. Are you seeing any impact in the market? Is that leading to better margins for you, lower prices to the consumer, better margins for the retailer? Any comment you can share there? And then the second question, can you remind us in terms of your plans in British Columbia to convert more of your automated greenhouses to cannabis? I mean I hear more companies going asset-light. You have more demand on the wholesale side, and then you continue to gain share on the branded retail side. So just an update on that, please. Thanks.
Michael DeGiglio, CEO
I'll address the second question first and then pass it to Mandesh for the first one. We have our third greenhouse adjacent to the other two used for cannabis, and its size exceeds the combined area of our two cannabis greenhouses. Our focus is on retail and building our brands in that space as well as exporting. We do not plan to invest in converting that greenhouse for B2B purposes as it's not our long-term strategy unless we see a potential for market share growth. If we were to convert that greenhouse, we would have the capacity to serve 35% of the domestic cannabis market in Canada. As imports increase, that remains an option for us. Additionally, the facility is divided into two parts, allowing us to manage production differently than we could previously due to early Canadian legislation requiring single crop production. That's where any change would occur if it were to happen. Mandesh?
Mandesh Dosanjh, Head of Canadian Cannabis
Thank you, Mike. Pablo, regarding your question about the OCS announcement, they revealed two key points. Firstly, they will implement a fixed markup and reduce some of their margins for consistency. They stated this will result in approximately a $60 million impact on the OCS dollars, though some details are still to come. A webinar will be held to provide more information, and these changes are expected to be rolled out later this year. It's important to note that it will be up to the producer to determine how the OCS's margin adjustments will affect MSRP. This could have a significant annual impact for any producer with a substantial market share. For instance, if there’s a $60 million impact at OCS and you hold a 10% share, that could mean around $6 million being reflected in your margin profile each year. We are enthusiastic about this development, as it highlights OCS's leadership in recognizing market conditions and addressing their previously high margins. With current challenges like excise tax and overtaxation, I commend them for this decision. Ultimately, it will be up to the producers to decide whether to reinvest in pricing or maintain their margins. We are optimistic, as this presents opportunities for both investment and pricing strategy adjustments, suggesting it could lead to margin improvements for us and others in the industry.
Pablo Zuanic, Analyst
That's good. That's very helpful. And then just a follow-up, Mike. Any lessons from the CBD deal, right? I understand the market has worked out for many people that made investments there. So you're not alone. But were you able to leverage your distribution capabilities on the produce side to improve CBD sales? Just lessons, I guess; I don't want to call it a postmortem, but in terms of where are we there and what's the outlook? And then a very short question regarding the Texas optionality. I get the idea; it's always been about in the future, interstate commerce. But short answer, the fact that you have those greenhouses there doesn't necessarily give you an edge if Texas was going to implement a medical program, for example, right? If you can comment on that? Thanks.
Michael DeGiglio, CEO
I recognize that our perspective on the CBD market is influenced by our industry involvement. Many consumers in the U.S. have integrated CBD products into their lives, which is remarkable. However, we haven't been able to fully utilize our strong relationships with retailers because they are waiting for FDA guidance. In my view, the FDA is overly aligned with pharmaceutical interests. Until there is a legislative clarification about CBD consumption, many retailers will hesitate to proceed. Some bold retailers understand the significance of CBD, recognizing that we possess an endocannabinoid system, which is crucial for our well-being. The situation in Washington is hindering progress, not just regarding the legalization of recreational cannabis but also concerning health-related matters. We view CBD as a health and wellness product, and it has shown great potential. We need our lawmakers to take definitive action, but we believe that once the FDA provides clarity, CBD will become a major consumer product. As for our business model, it has been successful in Canada and is directly applicable to the U.S. states like Washington and California, which are pushing for interstate commerce. I foresee a future where quality production will shift to larger-scale, lower-cost operations, regardless of the current pricing challenges. Despite experiencing setbacks last year, we aim to maintain a positive trajectory with our Fresh business, as developing new operations will require significant investment and time. We are also exploring various entry points into the U.S. market for 2023, focusing on regional opportunities without trying to cater to everyone. Our efforts have been constrained by regulatory challenges, but we remain committed to our strategy without incurring losses.
Pablo Zuanic, Analyst
Given that you mentioned it, Mike, I don't want to take up too much time on the call, but are you suggesting that you would consider expanding the listing from NASDAQ and also elevating the TSX in order to enter the U.S.?
Michael DeGiglio, CEO
Well, I will say this: there was a quote by Hannibal hundreds, thousands of years ago that said we will either find a way or make a way. And I'll leave it at that.
Operator, Operator
Our next question will come from Michael Freeman of Raymond James; your line is open.
Michael Freeman, Analyst
Congratulations on your significant progress in improving the Fresh Produce business. This is very promising. My first question is about the international business. You began shipping to Israel in the first quarter. Could you provide us with an overview of the volumes and how you anticipate the cannabis segment revenue will be influenced by international sales during the first quarter and into 2023 overall?
Michael DeGiglio, CEO
Overall, we feel optimistic this year. We have budgeted around 10% of our revenue for international markets in 2023, specifically targeting Australia, Israel, Germany, and England. While there is potential for more, we prefer to take a conservative approach because of the regulatory processes involved. Completing the necessary import permits and coordinating with different governments takes significant effort. However, we are encouraged by the favorable margins and tax structures in these markets, which we believe will yield higher margins compared to our domestic sales in Canada. Our plan this year includes establishing a team focused on exploring entry points in various countries over the next two years, aside from our ongoing efforts in the Netherlands. I am very optimistic about our presence in the Netherlands, as it marks our initial footprint with physical production assets in Europe. Our roots are in the Netherlands, where we have great respect for its top agricultural producers. We see a tremendous opportunity to leverage our position, introduce Canadian brands, and gain insights into consumer preferences across Europe, paving the way for substantial growth in the coming decade.
Michael Freeman, Analyst
Okay. Great. This is a nice new chapter. And then just quickly on the Canadian cannabis side. I wonder if you could comment on the inventory write-down and whether we should expect further write-downs heading into 2023. And then very quickly, when were the price increases implemented on certain products in Canada?
Michael DeGiglio, CEO
Okay. So Steve will answer the first point, Mandesh the second part.
Stephen Ruffini, CFO
Regarding the inventory write-down, we identified that it consisted of older and aged inventory at year-end, mostly over 15 months old, with lower potency and smaller buds. We adjusted its value to align with current market prices because that’s our approach. We have been selling that product, and it's not that it hasn't been moving; we simply adjusted it to match the market price. Some of this inventory, particularly the smaller buds, will be incorporated into pre-rolls. Thus, it will be sold over time, mainly influenced by the current market pricing for our comparable biomass inventory in Canada today.
Michael DeGiglio, CEO
Yes. And I would also say that if you look historically in Canada, our write-downs on inventory have been, I think, very low compared to most of the other part – the other part of the industry. Mandesh?
Mandesh Dosanjh, Head of Canadian Cannabis
Yes. So, Michael, your question was around the timing of the price changes. So we've started to roll those out now, and depending on region, that’ll be executed over the next quarter or two.
Michael Freeman, Analyst
Okay. So, to be clear, did you implement these at the start of March?
Mandesh Dosanjh, Head of Canadian Cannabis
They will start rolling out this month. That's correct. Sorry; you cut out for a second. So yes, they'll be starting to roll out this month and then ongoing depending on the region.
Operator, Operator
Our next question will come from Andrew Partheniou of Stifel GMP.
Andrew Partheniou, Analyst
Maybe going back and diving a little bit deeper into something talked about previously, first on the Permian divestment and how that could impact your gross profile in Produce. You talked about its one-third of your footprint there, but you also have Delta one. On the other hand, understanding that Produce is a very heavy fixed cost business. Putting it all together, could you give any kind of color on returning to positive gross margin in any quarters in 2023? I know Q4 is typically the highest margin quarter if you talk about a seasonal basis. So, without the Permian dragging on results, given that you were almost achieving positive gross margin in this quarter, could we see positive gross margin at some point next year?
Stephen Ruffini, CFO
Yes, Andrew, this is Steve. Yes, the fourth quarter's gross margin was primarily impacted by Delta 1 with the brown rugose. As you said, it's a fixed cost business, and that crop is now over. So those crop costs flush through in Q4, which was the main driver. The Texas operations that were in production, Permian Basin was not in production in Q4. It was due to inspection in Q1, but the Texas operations did have positive gross margins in Q4. So the negative gross margin is 100% due to the brown rugose impact on the Delta 1 facility.
Andrew Partheniou, Analyst
Sorry, I was on mute there. And then maybe going back to your production on the Canadian cannabis side, understanding that you guys pride yourselves on having amongst the lowest amount of write-downs in the industry here. Could you talk a little bit about where your Canadian cannabis production is at right now? Remind us, are you producing at 100% capacity of the facilities that you've already converted and you're selling at all? Have you thought about adjusting your production either upwards or downwards? Because it seems like there's two different things happening, right? You've got a little bit of an inventory write-down here, but you also have the choice that you've taken to increase prices versus maybe balancing that out with increasing production. So just trying to put it all together and get a big picture here.
Michael DeGiglio, CEO
Yes. Andrew, the inventory write-down was not due to our inability to sell but rather a change in the market. Over the past five years, consumer preferences for THC levels have shifted significantly. As consumer needs evolve, we must adapt accordingly. Agriculture can be unpredictable; the ideal strain, THC level, and desired characteristics don’t always align perfectly during cultivation. If we're not comfortable endorsing certain products at retail, as Steve mentioned, we can explore other avenues for them. The write-down primarily reflects pricing adjustments. Regarding capacity, we began with Delta 3, which spans 1.1 million square feet. We then initiated Delta 2, the same size as Delta 3, and operated at 50% capacity, never exceeding that. Currently, Delta 3 is at full capacity while Delta 2 remains at 50%, a level we chose not to increase. We feel confident in this setup due to our plans for international expansion. Our confidence stems from our competitive domestic production costs in Canada. When we launched retail a couple of years ago, we entered the market at a price point 31% lower than the next highest licensed producer, not to undermine competitors but to effectively compete against illicit trade. We believe our cost advantage will translate internationally, as mentioned by Mandesh. While we weren't the first to enter the export market, we aim to accelerate our efforts. We anticipate additional capacity growth in 2023 and 2024 and feel very confident in our current production levels. Mandy, would you like to share any additional insights?
Mandesh Dosanjh, Head of Canadian Cannabis
Yes. Andrew, good question. Every month we assess kind of 5, 6 months out because of the crop cycle, what we want to do on inventory plantings and how we run the facilities. That’s an ongoing conversation where we're trying to dial in the best we can. It's not the way you can grow; it's about what you can sell, and you want to align those two as best you can. Right now, we are running, like Mike said, the facility in half. It's running at full operation, full tilt right now. We're heading into some of the best growing conditions all year, just kind of given the spring summer months, it's arguably some of the best conditions we get in terms of yield and results. So we're hitting that peak right now. We're constantly evaluating it and looking at our outlets and what our sales and demand cycles are. We feel confident in our approach and our ability to match the two. We like where we sit now, and the pricing adjustments, yes, we're driven by how we're seeing demand go, and we believe there's an opportunity for us to improve our margin profile. But it's not really meant to stunt any demand or sales growth. We'll take advantage of our ability to operate and leverage our capacity to look at opportunities on the domestic side and then use extra production planning capabilities for international sales that are starting to ramp up.
Michael DeGiglio, CEO
Yes. And I would just one other thing. I mean, we're as you know, we’re in Quebec now; when we made this decision for Delta 2, we took into account that we would be operating in Quebec. As you know, we have a production facility there. We want to make sure that we have insurance that we always have enough capacity to meet the demand too.
Andrew Partheniou, Analyst
If I can just ask one more follow-up on this question here. Understanding that you still have the other half of Delta 2, what would you like to see before you decide to turn on the other half of Delta 2?
Stephen Ruffini, CFO
Andrew, this is Steve. We would appreciate a change in the excise tax system. The difference between our gross and net income reflects the excise tax we are paying based on our results. We pay more in excise tax than we do for all of our Pure Sunfarms employees combined. As others have noted in social media and the press, the current excise tax system benefits the government financially and poses challenges in terms of return on investment, especially considering current interest rates. If you calculate our net cash return from the Canadian cannabis business, it simply doesn’t add up under the existing excise tax; we would like to proceed, but not under the current tax structure.
Michael DeGiglio, CEO
Yes. I would like to add that we have already spent most of the capital costs associated with the second half of Delta 2, so it won't be a significant burden for us to proceed with production. We're not focused on a return on invested capital since the investment has been made. It was beneficial to do everything at once; remobilizing would be costly, and ordering all necessary equipment for the conversion is more economical. We can manage that. If international demand triples, that could be a catalyst for us, as there is no excise tax and the margins are significantly better. However, in Canada, it's challenging to justify the current situation.
Operator, Operator
And this will end the Q&A session for the call. I would now like to turn the conference back to Michael DeGiglio for closing remarks.
Michael DeGiglio, CEO
I just want to thank everyone for your participation today, and we feel very confident for 2023 and the direction we're going. Thanks for participating today, and look forward to chatting with everyone in May. Thank you, Chris.
Operator, Operator
Welcome. This will conclude today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day. Thank you.