Village Farms International, Inc. (NASDAQ:VFF) Q3 2020 Earnings Conference Call November 13, 2020 8:30 AM ET

Company Participants

Michael DeGiglio – President and CEO

Stephen Ruffini – EVP and CFO

Conference Call Participants

Doug Cooper – Beacon Securities

Rahul Sarugaser – Raymond James

Adam Buckham – Scotiabank

Aaron Grey – Alliance Global Partners

Scott Fortune – ROTH Capital Partners

Eric Des Lauriers – Craig-Hallum

Andrew Partheniou – GMP

Operator

Good morning, ladies and gentlemen. Welcome to Village Farms International’s Third Quarter 2020 Financial Results Conference Call. Earlier this morning, Village Farms issued a news release reporting its financial results for the third quarter ended September 30, 2020. That news release along with the company’s financial statements are available on the company’s website at villagefarms.com under the Investor’s 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 the 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 the 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, 2019, and the 10-Q for the quarter ended September 30, 2020, which are available on Edgar.

These forward-looking statements are made as of today’s date and except as required by applicable securities law, we undertake no obligation to publicly update or revise any such statements.

I would now like to turn the call over to Michael DeGiglio, Chief Executive Officer of Village Farms International. Please go ahead, sir.

Michael DeGiglio

Thank you, Carol, and thank you, everyone for joining us today. With me on today’s call is Village Farms’ Chief Financial Officer, Stephen Ruffini.

This morning I’m going to spend a few minutes highlighting the key takeaways for the quarter. Steve will then review the financial results and I’ll return with some concluding thoughts and then we’ll have some Q&A.

The first highlight that I’d like to call out is profitability. Village Farms once again achieved positive EBITDA with contributions from each of our business segments cannabis and produce. Produce showed another strong improvement year-on-year and grew quarter-on-quarter as well. And Pure Sunfarms posted its eighth consecutive quarter of positive adjusted EBITDA and more importantly, its seventh consecutive quarter of net income. That is an achievement that is unmatched by any other Canadian cannabis supplier. Pure Sunfarms quarter-on-quarter growth was driven by increases across all key metrics.

From my seat, this is harder in profitability that demonstrates the underlying strength of our business model, coupled with execution expertise, which shows on both Pure Sunfarms cannabis market experience and Village Farms 30 plus years of experience in large scale, low cost intensive agriculture.

As we welcome back this expertise under one roof with the closing of the Pure Sunfarms acquisition, we look forward to even more opportunities ahead. On our last conference call I shared with you, Q2 was a profound quarter for Pure Sunfarms, proving out that even with a very high proportion of sales derived from our large format, lower price offerings, Pure Sunfarms could be profitable.

The third quarter now is evidence of the earnings power Pure Sunfarms as sales grow. And as Steve will discuss, the composition of those sales in Q3 swung back to larger proportion of small format product sales. An example would be our 3.5 gram offerings as a centerpiece, which currently drives our brand awareness, B.C. grown branded house strategy.

The second highlight I’d like to discuss is related to profitability in that it is a key driver of our success in the matching a leading share of the branded retail market, and growing our wholesale channel sales and that is quality and cost of production.

It’s a vicious [ph] circle built and operate the most efficient operations to produce quality cannabis products to grow market share and drive profitability. The more brand strength we build, more of our markets profit pool we should be able to claim. On these calls we shared with you the market share data that is available, and we hope that you will continue to benchmark ourselves, as we have only been in the retail cannabis space for one year. I am pleased that the sequential sales growth was a combination of underlying market growth, new product launches, brand performance and a more normalized sales mix.

In Ontario, which provides some market share data that we all are able to discuss. The Pure Sunfarms brand again, led all individual brands in terms of both volume sales and dollar sales in the dried flower category which is under 30% share by volume. That number jumped in excess of 15% in October.

We also remained a top selling brand by both volume and dollars, not just for the year-to-date, but going all the way back to the launch of our retail products one year ago. It’s a remarkable consistent performance unmatched. As you know, from the beginning we have believed in a rather simple and straightforward business model, firmly rooted in our scale and efficiency. Our cost of production is still the lowest among publicly traded greenhouse and indoor producers, and significantly lower than the vast majority of our peers. This is the key to our honest circle of generating profitability and brand investment. And here is how this standard, this is translated into our Q3 cannabis results.

Net sales increased 75% sequentially from the second quarter to just under $23 million, driven by strong increases in both retail branded sales and sales in the wholesale channel. And I will note that only a small percentage less than 5% of Q3 revenue was generated by the launch of our 2.0 products, which was very late in the quarter.

That drove a sequential quarterly increase in net income of 200% to $3.2 million. The third take away from the quarter is that the value of managing our business with prudence and discipline. From day one we have built and guarded Pure Sunfarms profitability and return on invested capital. We have done this with the advantage of our decades of experience. We did not over build as many others have, and as I will discuss more in a moment, we are actively managing our production levels to the ramp in market demand.

We continue to see increased activity in our wholesale channel, not the result of any shortage of supply in the market, but rather a strategic decision by some producers who have realized they can source high-quality product, perhaps at a lower cost and they can grow. We are encouraged by this activity, as it could mean better supply demand dynamics going forward.

We believe this cost quality advantage combined with our long-term capacity will be a significant competitive advantage for the foreseeable future. And we will continue to believe that we could supply as much as 30% to 35% of the total Canadian cannabis flower market would B.C. grown product in addition to being a leading brand in excess of 20% of the retail channel.

I do want to remind everyone that with the acquisition of the entirety of Pure Sunfarms, our Village Farms is now free to use our 2.6 million square foot Delta 1 facility for cannabis, production anytime we deem that it makes sense to proceed. As a reminder, Delta 1 is located on the same site as Delta 2 and 3, which provide significant advantages over geographically dispersed operations is highly scalable, and it’s about 20% larger than the Delta 2 and 3 facilities combined.

We are now back at full production at Delta 3 after scaling back during the summer, as we actively aligned our output and inventory with near-term demand, which afforded us the additional benefit of doing a complete cleaning and sterilization.

In addition half of the 1.1 million square foot sister facility to Delta 3, Delta 2 is completed. No other capital requirements with – and bring that into production into the next year.

The most important operational highlight of Pure Sunfarms during Q3 was the launch of our first 2.0 products and bottled oils in very late September. As we expected, the value proposition for our dried flower products that has resonated so well with consumers, high-quality products that people want at an approachable price is similarly resonating with consumers about vapes and oils.

These products embody our uncomprising approach to quality and our commitment to a pure cannabis experience. Our Full Spectrum 510 vapes are made with 100% pure cannabis extract, no flavoring agents added terpenes or thinning agents and of our best strains. Both our vape and oil products have had excellent traction out of the gate and have been very well received by consumers. Consistent with the pricing strategy for our dried flower products, we launched our oil and vape products at a price and quality that we believe will entice those still purchasing cannabis from illicit sources to transition to legal market.

As a reminder, the illicit market is estimated to still represent anywhere from around half to three quarters of the total annual cannabis sales, depending on market and geography. These continue to be the power uses of cannabis and will be a major driver of growth in the legal market. We believe that these consumers ultimately want to purchase their cannabis from a legal source and are happy to pay a fair tax in the process to do so with confidence in the consistency quality and safety of the product at the right price.

Increasingly, they will have access to such product as legal cannabis resale, network stores network rapidly expands, and again, we are uniquely able to take this market approach and be profitable. And I would like to once again publicly congratulate the entire Pure Sunfarms team, Mandesh and his whole group on their successful launch of 2.0 products. And yet another accomplishment by this remarkable group.

Our Q3 only further underscores the value and importance of our completion of the acquisition of the remainder of Pure Sunfarms last week. It brings out vision to take the unmatched assets, people and know-how of Village Farms to build the best cannabis business in Canada full circle.

So turning to our cannabis opportunities in the U.S., with the election behind us, we look forward to the regulatory clarity that may occur. We continue to be encouraged by the direction of the regulatory environment, and have been hard at work developing multiple parallel strategies to expand a number of potential paths to capitalize on this opportunity.

Internationally, we have invested in strategic partnerships like in Asia Pacific, Company Altum, which is making steady progress on the execution of its strategy, initially focused on the Hong Kong market.

So turning now to our produce business for a moment. As I noted in the onset, Village Farms has had another good quarter. The continuing strong price performance with tomatoes drove higher sales, and our continued progress in transition and growing capacity displaced through cannabis to our partner growers, as well as our continued focus on cost management contributed to a $4.2 million EBITDA turnaround to a positive $2.2 million. While these numbers are important in and of themselves, as you have heard me say many times what is also critical, important is the breadth and depth of the strength of the organization to the lives of produce business. It is the engine that is powering our outsize growth opportunities in cannabis and related opportunities, both domestically and internationally.

I’d like to turn the call over to Steve, who’ll talk to our financial results. Steve?

Stephen Ruffini

Thanks, Mike. I’d like to expand on Mike’s comment providing more background on the financial results, which support the Village Farm strategy. Our produce business, produce sales of $43 million for the quarter increased over 12% versus Q3, 2019. On the back of our average selling price of tomatoes increasing 30% year-on-year on lower tomato volumes, as we had no production from our Delta 2 facility in 2020, as is now being converted to cannabis production, as Mike mentioned.

The increase in produce selling prices essentially rolls directly into our gross margin, as there is no impact on our cost of sales. As such, we saw a year-on-year improvement in our Q3 gross margin of $6.2 million to $5.6 million from a loss in the prior third quarter of 2019, of $600,000. Our produce business had a 13% gross margin for the quarter, the incremental increase in our gross margin was driven by the higher selling price and lower tomato volumes, again due to the diversion of the Delta 2 facility.

Produce EBITDA increased by $4.2 million year-on-year to $2.2 million on the back of the improvement in our produce gross margin, which was offset by a lower year-on-year add back depreciation since the Delta 2 facility was not in production, and a higher year-on-year SG&A in Q3, 2020 versus Q3, 2019 of $1.2 million, which is primarily related to substantive expenses involved with the acquisition of the financing of the remaining Pure Sunfarms shares. I should note that these incremental SG&A expenses are not truly related to the produce business but are more corporate in nature.

Supply shortages due to the increase in grocery store traffic certainly helped to produce pricing in the late spring and throughout the summer of 2020. I’d like to extend our sincere thanks to all the Village Farms employees who have continued to work all out on growing, distributing and supporting our Village Farms produce brands, by getting our fresh produce on the shelves, our strategic retail partners in both the U.S. and Canada. The commitment by our entire workforce has truly been amazing throughout the pandemic.

I mentioned last quarter that the strong year-on-year pricing would result in positive EBITDA and cash flow in the produce business, and we expect this trend to continue for the balance of 2020.

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Turning to cannabis, a reminder for the quarter ended September 30, 2020, the Pearson Farms results have not been consolidated in the Village Farms Q3 results, as we own 58.7% of the Pearson Farms business during the [technical difficulty], but we did not control it until November 2, at which time we owned 100%. I will address the consolidation performance financial shortly.

As Mike noted, sales for the quarter was 75% sequentially, and we continue to build on our strong brand position, which I view as a strong indicator for our future, especially given the uneven year ago dynamics in the Canadian cannabis market. Pure Sunfarms retail flower sales represented 48.5% of our sales dollars for the quarter. The late quarter launch of Pearson Farms 2.0 products contributed 4.5% of sales this quarter, and wholesale sales made up the balance of 47% of our sales.

With the retail channel totaling 53% of sales Pure Sunfarms quarter-on-quarter growth and retail sales of 30% was driven by 166% increase in its small format SKUs, and a 30% increase in pre-rolls, which were offset by a 43% decrease in Pure Sunfarms retail large format sales. The large format sales in this quarter were as expected ongoing replenishment sales as compared to the second quarter, which were driven by higher launch related sales.

Our quarter-on-quarter average selling price did result in a 13.3% increase, which was driven by the increase in the ratio of our small format sales versus our large format sales, which enhances our margins, as well as an increase in the blended net wholesale pricing for the third quarter versus the second quarter. But wholesale prices were driven by spot market dynamics.

We mentioned sequential sales growth looking ahead to Q4, while we continue to experiencing continuing month-and-month, year-on-year growth in our retail and wholesale businesses. I want to remind investors that Q4, 2019 was marked by the pullback of retail buying by prevention buyers, who are managing the conversion to Cannabis 2.0 and their year-over-year inventory.

To-date, we have not seen any indication of this reoccurring, while Pure Sunfarms and our competitors still operate in a relatively new distribution system, and there remain many external economic factors, not to mention the pandemic that could slow our strong momentum.

In recognition of the overall supply situation in the market and our customer demand, we actively pared back our production during the third quarter, resulting in a decrease in our inventory, both by volume and value. Overall, Pearson Farms inventory balance including work in process decreased approximately 6% quarter-on-quarter, which for those that read our financial footnotes can be seen in footnote seven.

Inside of the overall inventory total we decreased our finished goods flower inventory by over 15% quarter-on-quarter. We continue to actively assess supply versus our demand. Presently, the Delta 3 facilities back in full production based on our sales forecasts. The ability to ramp-up and down our supply is one of the beauties of this crop versus our historical fresh produce crops, which are annual commitment. We actively changed trends to mirror our sales forecasts in order to maximize our cash flows, but more importantly to maintain fresh flower inventory.

Switching to Pure Sunfarms profitability. Gross margin for the quarter was 34.6% versus 33.4% in Q2, versus 68.6% in Q3 of 2019, which had a totally different demand dynamic. This quarter’s cost of sales includes an inventory write down of CAD1.4 million, $1 million for the distillate inventory purchased earlier for which the market value has dropped since our purchase. Without the write down, Pearson Farms adjusted gross margin was 40.7%, which is a true reflection of the actual gross margins achieved against this quarter. The remaining distillate inventory has been assessed versus the market value, and there’s no need for any further distillates write down. The distillate will be used in Cannabis 2.0 products in Q4 and early 2021.

We received finally of the Pure Sunfarms extraction license from Health Canada in September, and will enhance our gross margin in Cannabis 2.0 products. The vapes in the market today were manufactured by third party extractor, as such the margin on these SKUs was lower than on our flower products in the third quarter.

We expect our Cannabis 2.0 products to have a higher volume as we manufacture our own vape pens and other Cannabis 2.0 products in the coming quarters. It was important for Pure Sunfarms to launch these vapes and oil in advance to obtain extraction license due to the ongoing success of its flower plant.

From a gross margin perspective and retail versus wholesale, the margins were somewhat similar this quarter. Our retail margin was pretty consistent by format, so as we sell more small formats SKUs versus large formats, our margin is enhanced as occurred this quarter. As mentioned, we do expect an increase in our retail margin as we increase our Cannabis 2.0 product sales, and transition to our own manufacture 2.0 products.

Wholesale margins are driven as mentioned by spot market dynamics, which are heavily impacted by available quality and potency versus the needs of other LPs. We continue to actively access our mix of sales by channels.

SG&A expenses for the quarter for Pure Sunfarms decreased approximately 13% year-over-year, which is a result of COVID-19-related vape subsidies, without these subsidies SG&A expense were essentially flat year-on-year.

As Mike previewed during the last quarter’s call, we have made the decision not to provide detailed information on Pure Sunfarms kilograms sold or produced or provided average selling price or cost of production. As the market continues to become more sophisticated it’s not in our best interest to disclose.

As you can see from our Q3 gross margin percentage of 40.7% without the distillate inventory write down, as compared to our Q2 gross margin of 33.4%, we continue our strong financial performance consistent with the virtuous circle that Mike spoke of earlier. It is simply not in our commercial interests to be telling our customers our cost of production on margins. We have demonstrated a low cost production and brand quality, no need to give away proprietary information.

The Village Farms and Pure Sunfarms balance sheets continue to be on solid ground to support our ongoing businesses in the term gross objectives. Both entities have borrowing capacity on their existing bank loans. As we decided on September 30, 2020 for the first time my tenure at Village Farms, we had a net cash position of $22 million. Of course, we just paid CAD60 million or $40 million to complete the acquisition of Pure Sunfarms on November 2, as well issued a CAD19.9 million note or balance of $15 million due on May 2, 2021 to complete the acquisition. So we’re back into our normal net debt position as of today, but we are on firm financial ground with our ongoing positive cash flow from operations in both produce and cannabis.

Speaking of, as I mentioned earlier, our pro forma, as we mentioned our closing press release earlier this month, Pure Sunfarms have been fully consolidated in Village Farms results beginning on November 2. As such our Q4 results and full year 2020 results will include roughly one month of JV accounting i.e. October in Q4, and ten months of JV accounting for the full year 2020, and two months of consolidated Pure Sunfarms results in Q4, 2020 and for the full year.

Since the acquisition of the remainder of Pure Sunfarms is deemed to be material acquisition for Village Farms, we are required to file pro forma combined financial statements for the enlarged entity, though combining Village Farms and to Pure Sunfarms, as if the transaction occurred retroactively to January 1, 2020.

The report is due within 75 days of closing. For Canadians on the call this report you will know as a Bar Report, meaning Business Acquisition Report. In the interest of giving the market a view of the income statement and component of the pro forma report, we’ve provided within our press release this morning. As caveat in the press release, this is for informational purposes only and is based on preliminary estimates and accounting judgments.

Based on the early indication pro forma for the nine months ended September 30, 2020, our statutory reported income at $0.08 per share will be $0.13 per share, if the business has had been combined for the entire year. In our 2020 year-to-date nine months adjusted EBITDA would increase to $12.5 million from our reported year-to-date adjusted EBITDA $7.9 million, which I will note does include – we do include inventory write-offs in our adjusted EBITDA when we reported. We do not add it back.

As such, while still subject to the completion of the report, we are confident when we state the acquisition was very accretive for Village Farms, we are actively working on the fair market accounting of the transaction and look forward to completing and filing the required U.S. and Canadian reports as soon as possible and hopefully no later than early December.

I want to recognize and thank all the accounting staff for all their efforts and incremental work this year in converting Village Farms and Pure Sunfarms from IFRS to U.S. GAAP, as well as now the acquisition and consolidation of Pure Sunfarms into Village Farms.

With that, I’ll turn it back over to Mike.

Michael DeGiglio

Thanks, Steve. So going forward, the outlook for Village Farms I believe has never been so positive with strong momentum in the business and considerable opportunity still ahead. It was a very solid quarter of many accomplishments, the team has done a superb job. And going forward each quarter is marked by steady meaningful progress in our transformation to a vertically integrated agricultural-based CPG business, as we aggressively pursue high growth opportunities in emerging legal cannabis and related markets in the United States, and targeted markets internationally. We are proving out the value of leveraging the expertise, the people the institutional knowledge for new high growth, high value markets.

Pure Sunfarms is built entirely on the foundation of Village Farms, our model, our facilities, our people, our experience our knowhow, all of which set it up for success by allowing us to bring in the best management team in the industry and those are the Pure Sunfarms’ folks who continue to perform brilliantly.

Owning the entirety of Pure Sunfarms not only provides our company and our shareholders with the full contribution of its financial success, but as a sole owner, we are now in a position to work to capitalize on opportunities that were constrained by this particular joint venture. We expect continued steady strong sales momentum based on a number of very clearly visible factors.

Growth in the Canadian cannabis market, which should be accelerated by the swift opening up new retail stores, especially in Ontario, British Columbia, the ramp up of sales of our vape, oil products and the introduction of new 2.0 products, and a natural shift in the market landscape to fewer suppliers. This momentum combined with unmatched North American assets totaling over 10.5 million square feet, more than half of which is in the United States and which no other cannabis company in the United States or Canada has, is why we continue to be so confident in our prospects for low and high THC cannabis markets in the U.S. and internationally.

We have the considerable benefit of being able to pursue these opportunities funded by our produce business, which again is performing quite well. All this continues to position our company to deliver growth and generate a return on invested capital, that leads our industry and drives value creation for all our shareholders.

So with that, we’ll open up to any questions. I’ll hand it over to Carol.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question this morning comes from Doug Cooper from Beacon Securities. Please go ahead.

Doug Cooper

Good morning, everybody, and congratulations on a great quarter. Steve, I just want to start with clarification on revenue per gram. You said it was up 13.3% sequentially. And is that just on the retail side? Or is that an average pricing between retail and wholesale?

Stephen Ruffini

Across all channels.

Doug Cooper

Okay. And can you talk a little bit about the difference maybe between the retail pricing and the wholesale in terms of – if you don’t want to give exact numbers maybe just the quantum difference between the two that you’re seeing?

Stephen Ruffini

Again, the range of wholesale pricing is all over the place, whether we’re selling for instance trim or selling high potency grade 1 flower. So the range is much broader. The retail pricing has been pretty consistent quarter-on-quarter between Q2 and Q3, large format, small format. But essentially, our average price was the enhanced [ph] and our margin was enhanced, in Q3 versus Q2, because as a percentage, we sold more small format in Q3, as a percentage of retail sales that we did in Q2, which was predominantly as we mentioned on that call driven by large format.

Doug Cooper

Can you give us some idea of the breakdown on the retail side, the breakdown by region, say Ontario, BC, Alberta? And then did you have much sort of loading into Saskatchewan, I think that came live in the quarter if I’m not mistaken.

Stephen Ruffini

Well, Ontario clearly continues to be our largest customer. And also impacting pricing is there are pricing differences on the format between the provincial buyers. So it’s not like a national price, so it does vary. So a weighting of sales into one quarter into one province versus another quarter also will impact the average selling price for a particular quarter.

Michael DeGiglio

Yes. I think going forward, Doug the aggressive growth in retail stores at Ontario as talking about right now very aggressive over the – starting now over the next year coupled with BC. I think that’ll continue to drive more penetration going forward in Ontario seconded by BC.

Doug Cooper

What do you think the optimal split in your business is between retail and wholesale? And Mike, can you just comment maybe a little further, maybe I’ve missed it. And you’ve talked about maybe a number of suppliers dropping. Can you just expand on that a little bit?

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Michael DeGiglio

Well, that’s a perception. But I guess I’ll expand on it by saying there are many examples of premium brands, CPG companies, that are very well-known brands have huge penetration and market share, but have a wholesale strategy. There’s a lot of examples of that. And it’s still a very massive industry and we want to keep our options open where we’re going. For us, we’ve made the investment already to capital investment in Delta 2, which can double the capacity right here with Village Farms.

And as I mentioned on my remarks, we have Delta 1, which is larger than those two, cumulatively. So, our focus is as a branded house to continue to maximize market share at the retail level. But right now, I think a wholesale venue for us works. There’s a lot of smaller companies that have a unique niche in the marketplace or doing unique things that don’t have cultivation. And to the extent that those companies are innovative and maybe doing things we won’t do, or can’t do, or may never do, why not have a relationship with that.

And there are some companies, in our 30-year history in produce, even though 75% to 80% of our sales are direct to the retail trade. We’ve always had relationships that make sense on portion of our business. So I think, I’d rather not say there’s not really a goal what that percentage will be, Doug, but we’ll see how it goes over the next two years. It should be a lot of interesting changes in the Canadian landscape.

Doug Cooper

Okay. Do you have a – you talked about the breakdown, maybe just talk about Ontario, in particular breakdown between sales is at the retail level between flower and 2.0 products. And I guess I’m just trying to – if 2.0 products were 4.5% of your sales, what do you think they could be six months a year from now?

Stephen Ruffini

We still believe flower rules. I mean, if you look at the U.S. or individual states, it’s still flower. And there’s no indication that that’s changing. I think we’ll see increased cannibalization of the illicit trade with 2.0 products, taking more of it as the stores rollout, and there’s a retail presence and the Canadian government maybe once there’s adequate amount of retail stores will shut down more and more illegal trades.

But as far as the split, I think 2.0 products will continue to grow, but the greater percentage is still flower. As I mentioned on the call, while 3.5 gram premier strains are doing very well, and we see that continuing to grow for the foreseeable future.

Operator

Our next question comes from Rahul Sarugaser from Raymond James. Please go ahead.

Rahul Sarugaser

Good morning, Mike and Steve.

Michael DeGiglio

Hi, Rahul.

Rahul Sarugaser

Thank you for those comments. Congrats on the rocking quarter. Well done, guys. So, first question is, clearly there’s a clear dominance in the devalue segment and flower. Now with the emergence of you’re putting out vapes on the market and noticing the pricing, I guess you guys have been pretty aggressive in pricing. So, how do you see pricing going forward driving revenue relative to the competition, particularly as retails opening up as you notice them, as you noted there, Mike?

Michael DeGiglio

Well, I’m just going to reiterate, Rahul, that our pricing strategy was always based on the fact that we saw the illicit trade. And the main consumer in Canada being the consumers been there for decades, the everyday user, the casual weekend user, and that’s the target market we’ve gone after.

And in order to provide, in order to cannibalize that customer to us, we have to order – offer all these key attributes, in terms of quality, potency, safety, so on, but at an affordable price. And that was coined by the team at Pure Sunfarms, early on affordable luxury. And that’s a focus of it.

So, that’s where we’re positioning the price points. And we’re doing that more or less at all the products we launched. Now, if that price point is 30% under other competitors, so be it. You just have to live with it, because that’s setting the market. It’s a $5 billion to $6 billion illicit trade market that needs to come here. So, that’s how we position the pricing going forward.

Rahul Sarugaser

Okay, great. Thanks so much. And then in terms of the wholesale community, that was relatively large portion of your total rev. So, number one, do you see that some being durable? Are you seeing durability in that going forward?

And also, maybe provide your comments in the context of the recent Croptober of outdoor grow? And how do you see Village Farms products competing particularly in the wholesale market relative to all of that outdoor grow?

Michael DeGiglio

Well, wholesale has a stigma attached to the term. So, maybe the correct term is in wholesale, as opposed to alternative channels. An example would be, I mean, private brands. I mean, if Costco in Canada wants to eventually sell cannabis under their corporate brand name, I mean, that’s an alternative channel. So, I think wholesale tends to have this stigma that it’s not important. And again, I think it’s too early to tell, but we will look at those relationships that we think could be meaningful. We’re profitable to use the term wholesale. We are profitable at the wholesale level, we prove that all along.

So right now, when we look at the fact that we’ve made our investment in Delta 2, but we weren’t quick to put that in production. We’re very prudent with our decisions. We don’t want to produce anything that we can’t sell. And we’re going to be patient as we ramp that up. But we can look at alternative channels and still remain true to our positive cash flow. So, I looked at it as a combination of wholesale private brand, other markets, other channels that people are doing very innovative niche-oriented offerings and see how that flows in the next couple years for us.

Operator

Your next question comes from Adam Buckham from Scotiabank. Please go ahead.

Adam Buckham

Good morning. Thanks for taking my question. Now I understand the Canadian rep market is both volatile and dynamic. But as we think about Q3 flower mix versus moving forward, do you see this quarter as a more normal mix? Or do you think there could be further shifts in small format in the near-term?

Michael DeGiglio

I think, I would say, a more normal, certainly much more normal quarter, the second quarter. And certainly, for us, if you remember last year, Adam, I mean, we didn’t have our sales license, so basically almost into the fourth quarter of last year. So, it’s been one year. So, we can’t really look at how we performed last year. As Steve said in his comments, it was a different market last year, and we were selling solely 100% wholesale from the first, second, third quarter.

So, for us getting some historical data going forward is what we need. The second quarter of this year and to an extent the third was really impacted by COVID, especially the second quarter, you’ve heard people, other companies saying, pantry hoarding and so on. And I think the fact that we launched a large format at that time was advantageous. It was the right product at the right time.

But I think this third quarter has shown where there’s more normalization between our offerings. And it’s early for us on the 2.0, we just launched it at the very end of last quarter. We’re very pleased where we are today. We didn’t want to talk about any specific numbers at this point. But I can tell you, we remain very confident in the direction we’re going from the early numbers we’re seeing.

So, I think it’s a great question. And I think the fourth quarter will probably help reinforce what that balance will be.

Adam Buckham

Okay, that’s great. Thanks. And I was just wondering if there’s any updates on progress on signing some new provincial customers.

Michael DeGiglio

Well, there is progress. I mean, we’re still eyeballing Quebec. The team’s doing a lot there. It’s not an easy penetration. But we feel confident that slowly we’ll make an entree into that and that’s clearly at the top of the pinnacle right now is Quebec.

But I think what’s more interesting for us is finally the traction that Ontario and British Columbia showing in opening stores. Ontario’s talking about in the realm of 40-50, 30 to 50, 30 to 60, stores promoting on the month, looking at 500 stores by April, doubling that to 1,000, by next September, that is very, very exciting for us. We’ve had conversations on greater capacity. And I think British Columbia is moving in that direction not as aggressively.

And I’m excited about it, because we’ve always talked about the fact that it’s like the end of prohibition in the U.S., except that the government of the U.S. did nothing, they shut down the Kentucky Moonshine. So at some point here, when there’s enough retail stores and a great channel for legal product, then we hope that there will be some pressure on the illegal trade, and that will continue to increase greater penetration and market share for us going forward.

Operator

Your next question comes from Aaron Grey from Alliance Global Partners. Please go ahead.

Aaron Grey

Good morning, guys. Congrats on the quarter and as well as the recent acquisition of Pure Sunfarms. First question for me, Mike you just mentioned that you’re pretty encouraged by the 2.0 products thus far, having just recently launched them in September. Just wondering if you could give any incremental color there? It’s been another category where you’re starting to see some pricing pressure, even just looking at the OCS website, they have specific dedicated kind of channel just for like under $5, I’m sorry, $7. So just curious towards what you’re seeing in terms of the dynamics? And how you think Pure Sunfarms has been positioned, especially kind of leveraging the brand equity you guys have right now within the flower category? Thanks.

Michael DeGiglio

Oh, I didn’t realize the price was that attractive. I must have missed that, but anyway. We didn’t put some now – I mean, Steve alluded to in his comments that we launched early, and we were – because we waited a long time as you know, for our final extraction license. We’re in extraction mode now. So we weren’t that concerned with the margin. We kind of knew what our margin could be at a given price. And we knew we were going to go out probably somewhere in the realm of 30%, under the existing competitors, again, tied to the illicit trade and mimicking what we did on the flower side.

So, we think, for the most part, we were going to allude to that we’re a leading vape brands or kind of leading today, but we didn’t say that so much in a release. But we’ve seen some data where we’re sort of in the top three so far, and that’s very encouraging both on the quality of our offerings there.

So I think pricing wise, we think the margins are going to come in very similar to our margins on flower right now, once we get traction. And I think that visibility will be there when we report the fourth quarter. So there is going to be price compression, but that’s something that we said from the day one. So we’re prepared for it and our models based on that.

Aaron Grey

Okay, great. Thanks for that color. And then second, obviously, Ontario has been a great province for you guys, you’ve done really well in terms of market share. But kind of asking in a different way in terms of some traction with other provinces, specifically looking at Alberta which is also a big province for Canadian cannabis. Can you talk about some of the traction that you’ve had there and maybe how it might be different, considering we’re seeing in Ontario, because obviously, you need that great market shares in Ontario? So, can you talk about the trends and maybe the differences in terms of buying patterns for the provincial buyers? Or what you’re kind of seeing in Alberta?

And when we might be able to see some more traction from some of those markets, too, because you’re just been doing so well within Ontario? Thanks.

Stephen Ruffini

Yes. I think the reason we talk about Ontario is because we have the data, and we don’t have the data in the other provincial governments, so we don’t feel like we should talk about it, because we’d be speculating someone. We’re Ontario, we’re very pleased that we get that data. So, I wouldn’t want to talk about it other than perception, and my perception from the Pure Sunfarms feedback is we’re doing pretty well and Alberta and BC, except that BC needs to really increase the amount of stores that really needs to happen. They’ve been pretty slow. It’s still the number one consumption in Canada.

So, the good news is, there’s a lot of growth there based on cannibalization of the illicit trade. And the second good news is that traction is starting to be recognized in BC, but it’s going to take time. Like for an example, even though we’re doing well in the province of Ontario, but if you look at, I was just talking with Mandesh yesterday about it, and like Mississauga, suburb of Toronto that has a million people does not have one retail store yet.

So, that city council, I guess has decided they’re not ready. So, that’s a huge potential down the road when and if that happens. And so that’s just an illustration of certain pockets that will take time to gear up on retail and we feel very encouraged about that. So, that’s the best color I can give on it right now.

Operator

Your next question comes from Scott Fortune with ROTH Capital Partners. Please go ahead.

Scott Fortune

Good morning, and thanks for taking the question. Can you provide just a little color on kind of cadence of 2.0 products? And the velocity there at the provinces, it seems there’s still like you said too many competitors in there, too many brands, some are moving and not all are moving at the inventory level for these provinces. Just kind of your sense for the velocity of your 2.0 products moving forward.

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Michael DeGiglio

Well, we sold that pretty quickly on the launch. So, we were actually – I was pleasantly surprised. So, it sold out pretty quickly. And the indications are we’re going to gain, we’re gaining and will gain more traction, including at our price point coupled with the fact that it’s pure cannabis, we’re using our best strains for the extraction. This is top of the lines, no by-products or any of that. And we think that’s going to resonate, well. We feel really good what our 2.0 line is just that – we don’t have even a full quarter under our belt. And we want to kind of just be a little more conservative so we can talk specifics.

So, but it is growing, the 2.0 products we have too, and we kept pretty myopic on where we were going with the products that have large market share. We’re not really focused on confectionery or beverage right now. Maybe that’ll come more in the future, those markets still are relatively small to us. So, we want to get our penetration higher, as quick as we can. And so far, so good.

Scott Fortune

And then follow-up on that, how many 2.0 SKUs you have out there? And then kind of what’s the sense for that picking up your trend to different products and SKUs as we look at the 2021?

Michael DeGiglio

Well, I think there’s about three, but we’re launching another vape product as we speak. And as I mentioned on the last call, we’re ready to roll out edibles in the foreseeable future. So, that’ll probably put us initially, somewhere between five and seven. And for us, that’s a good start. That’s a good start. Good launch. And once we get feedback, we’ll see consumer feedback. We’ll see what else we plan to do.

Operator

Your next question comes from Eric Des Lauriers from Craig-Hallum Capital Group. Please go ahead.

Eric Des Lauriers

All right. Congrats on solid quarter guys, and thanks for taking my questions. So, you mentioned that you’re at full production in Delta 3, and that Delta 2 could come online in 2021. Can you just help us understand what you need to see in the market before bringing Delta 2 online?

Michael DeGiglio

Well, we need to see what we’ve done like over the summer. We saw sort of things slowing down. And we felt it would be prudent. We always want to produce what we can sell. In fact, without giving any numbers out, if you just look in the third quarter like in August, we curtailed our production during the summer.

And if you remember, Delta 3 was converted, and we started to – we got into it originally wholesale production while we’re still doing the conversion. So it’s a great time for us to look at the market and say we better slow things down, move some of our inventory out. And in fact in August alone, in the third quarter, we sold more than double what we produce. So taking that prudent conservative approach on reducing our capacity over the summer proved out very well for us. Our inventory is right where we want it to be. The churn is solid. So now we’re back into full production on Delta 3.

It takes time, as you know, to ramp up. Now we’ve done the conversion and the capital is sunk into Delta 2. It’s just a matter of gearing it up. Our expertise, 30 years of gearing up, it’s a process, you just don’t get to excellence overnight. So we’re going to start gearing Delta 2 up to get our people up to speed. We envision that we’ll start looking at increased capacity, probably third quarter, and then prudently ramping that up based on our supply demand numbers. We’re not in any rush to go to overcapacity. So we’ll just be monitoring that every week as we go, or every month, I should say.

And then, keep in mind, the way our facilities are set up with 16 to 17 grow rooms, we have the capacity to bring on in a slow ramp up as opposed to just banging it.

Eric Des Lauriers

Okay, that’s helpful. I appreciate the color there. And then maybe turning to the U.S. Since the election, there’s been more talk of cannabis legalization in Texas. One law firm projected Texas could produce billions of dollars in tax revenue. And just this week, we’ve seen 13 pieces of cannabis legislation filed in the state. Can you comment on your readiness to serve a potential Texas cannabis market? And how your existing agriculture business could position you for a successful license application?

Stephen Ruffini

Well, I’m not going to front load any of our strategies except to say that we are working and have been working all out on multiple strategies. So we’re very excited about the U.S., but I don’t want to put anything out at this point other than to say that I think if you look at our playbook, our principles, the results and our achievements of what we’ve done in Canada. And by the way, we were nowhere near first, second or third in Canada, and now pinging today, we’re leading in every major metric from number one brand to a low-cost production, the most profitable, most consistently profitable.

And those results and achievements, I think, will go a long way to us entering the U.S. market. So, we’re looking at the regulatory process and we have multiple strategies, and I will say we’re very excited about the possibilities in the U.S. for the Village Farms.

Operator

Your next question comes from Andrew Partheniou from Stifel GMP. Please go ahead.

Andrew Partheniou

Thanks for taking my questions. And congrats on the great quarter guys. You continue to set yourself apart from your peers.

Michael DeGiglio

Thanks.

Stephen Ruffini

Thank you.

Andrew Partheniou

Just on the ordering dynamics from the provincial boards. Could you give us a little bit of color on how that’s going? We’ve already seen a little bit of shift from big initial bulk orders to smaller orders, but more frequent. Would you say that that is still the case? And you called out your initial launch on 2.0 products selling out quickly. How quickly did you feel that provincial awards reordered? And are you satisfied with the inventories that you have at the retail level?

Stephen Ruffini

Well, as I mentioned, I mean this is still a very new distribution system, provincial buyers are as an earlier analyst mentioned, have a lot of access of certain SKUs or certain strains or vape pens that aren’t moving. So, there’s a little bit of guesswork, I guess on their part.

We’ve been very happy with our sell-through. As Mike mentioned, we sold out of the vape pens, which on one hand, say, well, that’s a testament to strong demand, the flip side of that is, from the CPG standpoint, that’s a lost sale. If the consumer goes in asking for a Pure Sunfarms flower brand, or for a vape pen, and they’re out of stock, then they’re either buying something else, or they turn around and walking out of the store. So, that’s the lost sale for us.

So, as Mike mentioned, we’re continuing to get more data, we’re continuing to actively work with the provincial buyers. Again, a lot of incremental sales has to do with actively working with the buyers to make sure that store shelves are stocked with our product, and putting time and effort and people and resources behind major inventory at all levels, not just what we have on hand, but what’s at the retail level, and in the DCs is imperative to drive your long-term success of your brand.

Michael DeGiglio

Yes. And I think also, Pure Sunfarms team has told us that they all want to grow very much so. So, the collaboration is more positive than ever. And the orders are becoming more consistent than they have been. So as Steve said, and I think the teams noticed they’re getting better at their forecasts, and we see it exceeding, starting to exceed the orders they’re placing. So we think it’s definitely in a better place [ph].

Andrew Partheniou

Great. Thanks for that. It’s very helpful. Switching gears to your smaller product formats and how that might tie into the new strains that you’ve guys launched. I think strain innovation is probably a key thing that you guys have under your belt. And anecdotally I see on the front page of the OCS, you guys are called out with your 28 grams of Pink Kush for $5 a gram. So, can you give a little bit of color on what you guys are doing in terms of developing new strains, launching new strains? And how that might have played a part in the good growth of the small product format in this quarter?

Stephen Ruffini

Well, that product you just mentioned, it was personally earmark to analysts living in Montreal that would come down over the weekend, and low that. It’s a constant innovation process. I mean, they’re constantly obviously buyers, provincial buyers, consumers are always looking for something new and innovative. So, it’s a constant process. And that’s one of the reasons that the Delta 3 facility and the Delta 2 facility were designed the way they are with multiple grow rooms, so we can constantly try new strains, both in the marketplace but also on the cultivation standpoint.

Michael DeGiglio

Yes. And there’s a lot of strains in the pipeline, I mean, that connection to our brand. That’s one of the things about British Columbia, world renowned in cannabis production. And it’s a huge difference. That thread in the fiber of British Columbia cannabis is like no other in Canada, you’re just not going to see that in Leamington. So, that DNA, that history goes way back.

So, I can tell you there’s a lot of strains in the pipeline. And the team there looks very strategically as they launch them, how, when, where. And so I think you will continue to see, as Steve said, a lot of innovation coming forward with new strains and everyone is excited about it. I think that’s one of the benefits of our location in sort of the heart of cannabis territory in Canada.

Operator

Your next question comes from Doug Cooper from Beacon Securities. Please go ahead.

Doug Cooper

Hi, guys. Everything has been answered. Thanks very much.

Michael DeGiglio

Just the other day. Okay, we’re good. I think we’re good operator.

Operator

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

Rahul Sarugaser

Sorry, Mike. Just yes, one last question. So I know you said that you’d prefer to keep your U.S. strategy to yourself. But maybe if you can just sort of elaborate more generally, given the recent changes in the U.S. at the federal level. How you see things playing out? And how those farms would be able to compete generally, relative to the MSOs which are quite in favor at the moment?

Michael DeGiglio

Yes. Let me say this, I mean, the MSOs have done a great job. I think a lot of them, they’re pure play cannabis companies that have focused on bricks and mortar and distribution. But in time, we believe that interstate commerce will happen. And I think that’s one area that that’s where we shine the best. You just can’t have five, seven, eight production facilities in a given state, indoor five, six, seven growers or one grower going around if you’re going to really try to have incredible strains and consistency.

So one example, with MSOs is as successful as they are, and they will be more successful, especially the national ones, big market cap see pockets no doubt. But they’re going to have to find how they can be cost effective, because in the end, like we’ve proven in Canada, things will get competitive. And even if, in the end, there is a migration with technology, less in flower to other deliverables, I think we could play our part.

From a Texas perspective, if Texas, there’s a lot of bills out there. We don’t know, unfortunately, Texas meets every two years. So we have this one window between January and May, whether it’s a medicinal play there, I think first rather than RAC or nothing happens, and it’s two years out.

Once we launch in Texas, we will be sort of first in when assets ready to go. We already have our conversion plans. We’re ready to go in Texas. And that’s the size same population nearly as Canada and the way Texas is going to probably be very close the next few years.

So that in itself is like the Republic of Texas or a country. But that doesn’t mean we won’t work nationally. And we’re prepared to look at, if we have to do acquisitions or strategic partnerships and other locations, where we can bring our strengths to the table. I think there’s a lot of opportunity there. We’re pretty well known. As you know, Village Farms is in principle a U.S. company. That’s where we are. So it’s like coming home. But we’re excited about on ray of possibilities for us.

Rahul Sarugaser

Great, that’s all for me today. Cheers.

Michael DeGiglio

Thank you. Okay, thanks, Carol.

Operator

This does conclude the Q&A portion of our call. And I’d like to turn it back for any closing remarks.

Michael DeGiglio

Okay. Once again, thanks, everyone, for joining us today. And we certainly look forward to speaking with you on our next call, that’ll be a very exciting one for the fourth quarter yearend, full quarter of consolidation and updates on how well we feel we’re doing. I can just tell you, I remain the largest and happy shareholder on this call today. And I’m very excited about our opportunities going forward. I thank you for your participation today. Thanks, operator.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you once more for your participation. You may now disconnect.



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