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 fourth quarter ended December 31st, 2022. That news release, along with the company's financial statements, are available on the company's website at villagefarms.com under the Investors heading. Please note that today's call is being broadcast live over the Internet and will be archived for replay both by telephone and via the Internet beginning approximately one hour following completion of the call. Details of how to access the replays are available in today's news release. Before we begin, let me remind you that forward-looking statements may be made today during or after the formal part of this conference call.
Certain material assumptions were applied in providing these statements, many of which are beyond our control. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied in forward-looking statements. A summary of these underlying assumptions, risks, and uncertainties is contained in the company's various securities filings with the SEC and Canadian regulators, including its Form 10-K MD&A for the year ended December 31st, 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.
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 per our usual format, 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 in 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 Co., Soar, and Promenade. We generated our 17th consecutive quarter of positive Adjusted EBITDA. Importantly, we grew while integrating Rose LifeScience 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. It now ranks second. This is a great achievement in just one year. Just after quarter end, we further expanded our export markets with our first shipment to Israel and expect additional shipments to other countries in short order. Second, in our 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.
Once again, in Q4, the team's performance has made Balanced Health Botanicals 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 2021 and 2022 crop cycle in Texas alone. That's only in production cost and yield. It does not include the impact on customer relationships. It does not include the impact of the virus in 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, 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, that all cannabis in North America is out of favor with investors. Despite this, 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. 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 clear leadership position. Let me spend a few minutes clarifying our strategy. When and since we expanded to 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 of our Texas-based assets as worth much more, assuming produce broke even. 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-based assets as we have done and proven in Canada. How is this working out? On number one, as you can see from our results in 2022, despite very difficult market and regulatory conditions in Canada, which have hampered 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 option 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. I give us a D for this part of the strategy last year. On 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 runs itself. We recognize the need 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 our fresh business results. We have undertaken the following.
We will be reducing the footprint of our Texas assets to improve profitability and focus our cultivation assets and team 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 customer relationship to focus 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. 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 a top cannabis cultivation operation in the world.
As of the first two months of 2023, inflation and the Brown Rugose virus, which put some tremendous pressure in 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 attacked the virus, input costs, and pricing opportunities. They have made me cautiously optimistic. To summarize, we have launched a plan to de-risk the 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 owe this to our stakeholders, and we understand that as a business, Fresh must contribute to the growth of Village Farms. I will turn it over to Steve for more detailed review of the financials. Steve?
Thanks, Michael DeGiglio. Before I get into results, just a quick reminder on the impact of the acquisition of 70% of Rose LifeScience on November 15, 2021. Therefore, the fourth quarter and annual 2021 results only reflect six weeks of contribution in last year's comparisons. Turning to the results. Consolidated sales for all of Village Farms International for the fourth quarter were $69.5 million, which was a decrease of 5% from Q4 last year, due primarily to a weaker Canadian dollar in 2022 versus 2021. On a constant currency basis, our year-on-year sales were close to flat, year-on-year down 1%. Higher sales from the Canadian cannabis business were offset by lower sales from fresh produce. On a constant currency basis, our cannabis sales were essentially 50% of our consolidated U.S. dollar results.
Consolidated net loss for the quarter was $49.3 million or $0.41 per share, compared with a net income of $2 million or $0.02 per share for the same period last year. Our Q4 2022 net loss included the following significant non-operational charges to income due to balance sheet adjustments. Specifically, an additional $13.5 million impairment to goodwill in the quarter related to the value on our balance sheet of the acquisition price of Balanced Health Botanicals. This in addition to the June 30, 2022 impairment charge of $29.8 million as a direct result of the significant decline in the valuations in other CBD-focused peer publicly traded companies. The total impairment of $43.3 million for the year is a significant driver of our reported statutory full-year loss of $101.1 million.
We also, in the fourth quarter, wrote down in the Canadian cannabis business, took an $11 million U.S. or CAD 15 million charge for aged lower potency flower inventory. Additionally, we took a valuation allowance adjustment to our U.S. deferred tax asset, creating significant change in our 2022 tax provision, resulting in a $19.2 million charge to earnings in the quarter. These balance sheet adjustments totaled $43.7 million of our reported $49.3 million loss. Consolidated Adjusted EBITDA for Q4 2022 was near breakeven at -$756,000, compared to positive Adjusted EBITDA of $5.1 million in Q4 of 2021. The EBITDA loss in Q4 was, this year, was driven by fresh produce, although we saw a considerable improvement compared to Q3. Corporate costs were relatively flat year-on-year.
As I shift to Canadian cannabis results, I'll refer to results in Canadian dollars to provide more accurate gauge of our period-to-period performance amidst exchange rate fluctuations. Our Canadian cannabis operations delivered year-on-year growth in Q4 of 13% to CAD 38.2 million. Retail branded sales for Q4 continued meaningfully outpaced the market growth at 25% year-over-year. Wholesale sales for Q4, however, were down 35% year-over-year due to continued significant price erosion in the market as distressed producers liquidate inventories. This revenue channel can vary widely from quarter-to-quarter. This was especially the case in Q4. The wholesale pricing environment contributed to our decision to write down CAD 15 million of aged lower potency flower inventory as its expected realizable value was reassessed relative to current wholesale market pricing.
As it is sold, it will pressure our gross margin target range of 30%-40%. Excluding this write-down, which is recorded in our cost of goods sold for Q4 for statutory purposes, without this charge, our gross margin for Canadian cannabis in Q4 was 40%, at the top end of our stated target range of 30%-40%. Up from both Q2 and Q3 as we continue to execute on providing high-quality everyday priced products. Selling general and administrative expenses for our Canadian cannabis operations for the fourth quarter were CAD 9.8 million or 26% of net sales, compared to CAD 9.2 million or 27% of net sales in Q4 in 2021, and was a sequential improvement following our investments in the end of 2021 and the first half of 2022.
Remain on track to bring SG&A as a proportion of sales back into the lower 20% range in 2023. Q4 2022 SG&A includes severance costs of our publicly announced headcount reduction in early Q4. Our Canadian cannabis operations delivered their seventeenth consecutive quarter of positive Adjusted EBITDA at CAD 6.3 million, up from CAD 6.1 million in Q4 2021. I will now move to our U.S. cannabis operations and revert my review back to U.S. Dollars. U.S. cannabis sales for the fourth quarter, which continued to be generated entirely by Balanced Health Botanicals, were $5.3 million, which generated a gross margin of 67% that compares with sales of $7.5 million and a gross margin of 71% in Q4 last year, with the sales decrease primarily driven by the industry-wide challenges, although indications are that we are outperforming the majority of our peers.
Our back half 2022 results were driven in part by the success of our Synergy+ line of hemp-derived THC products. Adjusted EBITDA for U.S. cannabis was $300,000, compared with Adjusted EBITDA of $1.7 million in Q4 of 2021. Now turning to fresh produce. Although our financial performance continued to be impacted by inflationary pressures, especially for freight and other production inputs, and the volume loss due to the Brown Rugose virus, we delivered a significantly improved quarter, driven predominantly by improvements in our Texas operations, which are continuing into early Q1 2023 and are coupled with stronger year-on-year pricing. Adjusted EBITDA was negative $3 million, compared with a positive $700,000 in Q4 of 2021, and notably a considerable sequential improvement from the negative $4.9 million in Q3.
As expected, it really was a first half, second half story, with Adjusted EBITDA for the back half of the year improving to -$7.9 million from -$16.5 million for the first six months of 2022. Turning now to cash flows and the balance sheet. At December 31, 2022, we had $16.7 million in cash and approximately $44.1 million in working capital. During the quarter, we had a net cash outflow of $1.5 million, net of all operational capital expenditures and financing in the quarter.
Subsequent to quarter end, Village Farms management, our board, and our advisors made what we believe to be a prudent decision to raise $25 million through a registered direct offering of just under 18.4 million common shares at U.S. price of $1.35, together with warrants to purchase up to the same number of shares, which at their exercise price of $1.65, would generate $30 million in additional proceeds. We made the decision to raise capital last month based upon two factors. First, our best informed assessment of all the 2023 factors outside of our control. The second, a failed federal cannabis legislative agenda that might have delivered more efficient capital market fundraising. We felt we had the responsibility to our shareholders, indeed all stakeholders, to shore up our balance sheet so that we could focus without distraction on executing our operational plans.
Now I'll turn it back to Mike.
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 that 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 Curaleaf International 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 amount of taxation exists in other consumable product industry. We support all efforts to revise excise taxation levels immediately. With that, operator, we'll open up to questions. Thank you.
Thank you. As a reminder, to ask a question, please press star one one on your phone and wait for your name to be announced. To withdraw your question, please press star one one again. Stand by as we compile the Q&A roster. One moment please for our first question. Our first question will come from Aaron Grey of Alliance Global Partners. Your line is open.
Hi, good morning, and thank you for the questions. Hey, how's it going? First question from me, just wanna 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 can provide and maybe on what products or brands? How much are you willing to potentially cede some share in order to improve, you know, the profits and margin on that? What gave you the comfort to maybe implement some of those price increases now, just given the market's still rather fragmented and still seeing a lot of pricing pressure.
Maybe if you guys are, you know, building brand, but maybe if some others don't follow and you do cede some share, what kind of gave you the comfort to do that now versus waiting for some more maturity in the market? Thank you.
Well, thanks, Aaron. Before I turn it over to Mandesh, that was one of the last comments and became your first question. Interesting. Mandesh, do you want to give some color on that?
Yeah, absolutely, Aaron. Good question. I mean, we're not gonna give a huge amount of detail because there's a lot we looked at from a competitive set, but I'll answer some of your bigger points is. The first one was around share. We don't, it's not about ceding share for the purposes of improving margin. You know, we have a pretty robust understanding of what's happening at the consumer level, what's driving demand, and just making sure we understand pricing analytics and where there's opportunities. I mean, we're always evaluating, and I think right now what we see is a key opportunity to improve margin without impacting share. You know, always trying to improve margin, maintain or grow share is kind of our strategy. It's all about profitable market share and improving the dynamics there.
We see the opportunity and have implemented the opportunity across a couple of our key brands where, you know, just demand was outstripping some of the supply and really just sharpening across pricing sets within assortment in various regions as kind of the market dynamics were unfolding. Why did we feel comfortable? I know it's the strength of our brand, the quality, the consistency of our products and just the ability to compete in market. I think any strong CPG company with strong pricing analytics is always gonna sharpen their pencil when they think the time is right, and we think the time is right for us right now.
Okay, great. Thanks for that color, really appreciate that. Just kind of going on top of that in terms of some of the distressed sale of biomass that you mentioned, just any color in terms of how you think that will kind of unravel in 2023. Still looks to be a lot of inventory out there. How do you expect there to be a lingering impact, and are you comfortable with how you're leveraging Fraser Valley to compete in that value segment? You know, obviously I feel pretty comfortable with the pricing from the earlier comp tab we just talked about. Just wanna get some other color in terms of the broader market and more distressed sales and the impact that might have on you guys. Thanks.
Sure. Mandesh?
Yeah. Maybe I'll take it in a bit of a reverse order there, Aaron Grey. Your second part was around Fraser Valley. We launched Fraser Valley last year to compete in the value space of flower. It was an emerging space where as Pure Sunfarms was carving out a really solid niche and continues to in everyday premium. We felt like we were, you know, under indexed or not represented well 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 Donny Burger, a strain that's, you know, wildly popular across the country. In that brand, we think there's still a lot of opportunity.
We see that segment growing as we thought it would, as, you know, inflationary pressures with consumers and then tough economic times happen across the country. 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, and there'll be 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, you know, a value-based SKU that gives consumers great affordability and great offerings, and we'll definitely leverage it. It is an outlet for us on inventory that we're long on. Then, yeah, 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. You know, we have a good bevy of customers that we deal with on the domestic B2B side, and it's actually, it's allowed us to simplify. Customers who wanna buy consistent product that's available, that's consistently grown with great quality, I mean, they're coming to us. That's what we like dealing with.
We do see a lot of kinda irregularity on the spot market, and it's kinda feast or famine. We see a lot of inbound calls come as pricing or things dry up there, and I just don't think it's sustainable and then people are gonna be desperate. I'm not sure, Mike, if you wanna add any more color on the desperation of other producers or what's happening there?
Yeah. Well, I mean, we're really focused on the retail side, you can see it in the numbers, 25% year-over-year, as we mentioned in the call. Yeah, as Mandesh said, You know, it's not sustainable. It's just not durable long term. We have a real solid handle on our costs, and we think we know pretty well what the cost of production is by many other LPs. The prices that are selling for, it's just not sustainable. It may last all 2023, may even go into 2024. It's hard to really say. It is a perishable product. At some point, the value just diminishes. We'll be patient. That's the color on that.
Thanks, Aaron.
Okay, great. Thanks for the color. I'll drop back in the queue.
Thank you. One moment please for our next question. Our next question will come from Frederico Gomes of ATB Capital Markets. Your line is open.
Hi, good morning. Hi, thanks for taking my questions. Just my first question is on the divestment of your facility in Texas. How long do you think that sales process will take, and how much do you expect to sell it for? You know, any color on that front. Thank you.
Yeah. We're not gonna comment on the 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, 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. We have a large footprint there. 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 wanna focus our team on that larger footprint.
I think for Texas, when you really look at the ability to have an asset in Texas, as big as Texas is, an asset like this, it's very limited where those assets can be. We think it's a very valuable asset, and we're optimistic that the process will move fairly quickly, Federico.
Okay. Thanks for the color. 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? You know, you know, should we expect any uptick in sales from that category this year? You know, any new products, investments in automation, et cetera? Can you talk about that?
I'll turn it over to Mandesh to add some color, but I will start by saying that we consider pre-rolls really as part of flower as we classify it internally, and it is a very. It's a growing market for sure. As we speak, we just made another huge investment, capital investment in pre-rolls. We're very focused on it, and we're focused to win in that market. Mandesh, some color on that.
Yeah. Thanks for the question and appreciate the starting point there, Mike. Just to Mike's point, yeah, we did increase our capital expenditure to add additional pre-roll capacity. Rodrigo, I'll talk about the pre-roll and then the other kind of derivative-based products after. Pre-roll is a huge part of our strategy. I mean, we see that conversion from the flower, whole flower consumer wanting more convenience in pre-rolls, and we're absolutely continually looking at our assortment and launching new SKUs to match some of our new strain offerings that are in market, and then expanding into new strains that aren't in pre-roll. Big focus, not just in Pure Sunfarms, but also now with our Fraser Valley and then eventually...
Sorry, with our Soar Cannabis premium line, coming down the road with our Fraser Valley. Managing assortment in the pre-roll category, huge opportunity for us, I think you'll see more innovation there, we're continually getting more listings. A similar story on vapes. In the process of doing, you know, an interesting vape refresh on our main line and looking to expand that portfolio with great offerings. The infused pre-roll category. Obviously, a category that's definitely top of mind right now with consumers growing share in each of the key markets. For us, it's just about figuring out, doing a SKU the right way, the right profitable way, where we can grow meaningful and sustainable market share.
We're not always gonna be the first ones there, but we're gonna do it the right way. Lots more to come. We're just not resting on our laurels as, you know, the number one flower company in Canada. It's about looking at other opportunities, and it will be part of our 2023 and beyond strategy.
Thanks for that. I'll back to you. Thank you.
Thanks, Frederico.
Thank you. One moment please for our next question. Our next question will come from Scott Fortune of Roth MKM. Your line is open.
Hey, good morning.
Hi, Scott.
This is Nick Hatzis.
Good morning.
This is Nick Hatzis. 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.
Sure. Mandi?
Yeah. Sorry. I was just on mute there. Thank you. Last year, when we launched Fraser Valley, we were really talking to this group, the analyst group and kind of in market about, you know, 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 still being there and premium being, you know, 15% or so, 20% of kind of the full flower offering. You may see 15%-20% of any kind of category in premium. You see the bulk of those sales kind of 40%, 50% in core, and then another, you know, 20%-30% in value.
kind of, that's kinda how it's shaking out in certain regions, whether it's Alberta or British Columbia or Ontario, might be slightly over or under index. Now we're squarely positioned with three great brands in each of those, each of those segments. Value being Fraser Valley Weed Company, Pure Sunfarms playing in core, and now Soar Cannabis in premium. What we're seeing and our expectation for the year is growth in all three. We're not seeing cannibalization across that. I think that's a key piece. As we saw with the launch of Fraser Valley and Soar, we're getting, again, profitable, meaningful market share without impacting our core Pure Sunfarms offering.
I think that's the key for us is, you know, we took our time to launch these three brands, or 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. We're seeing that. The plan this year is to grow. Again, you know, in the premium market for Soar Cannabis, I mean, it's a much smaller market. The bulk of our growth will really come at Pure Sunfarms being the biggest brand, and then Fraser Valley being the second biggest. Those will be the two main drivers on growth.
we're excited with what Soar has done and already been able to take kind of a 1%-2% share of flower in the markets that it's operating in.
Got it. I appreciate that color. Just a second from me on the international side. You mentioned solid growth in Australia-
Mm.
Commencement of sales in Israel. Just wondering if you had any commentary on the newer markets. I know you're one of a few in the Dutch market, and it looks like Spain's looking to ramp capacity. Just any opportunities out there internationally that you're kind of looking at or evaluating, just some color there would be helpful. Thank you.
Yeah. I mean, Australia's really ramped up considerably. We're very pleased with the results in Australia, looking at New Zealand as well. On the European side, you know, it's just been a long process to really get into Germany. We're ready to go. We finally got our permits actually last week. It's really to hold up more on the Canadian side. Sometimes it can take 30-60 days, I won't elaborate much on it, but it's crazy. That should be forthcoming. Israel's gone very well on our first shipment. We're actually in pharmacies right now. We've seen pictures of consumers that are happy, we're excited to see where that can ramp up. The U.K., you know, we're gonna ramp up in the U.K. very quickly.
That's all the work has been done there, so we hope to announce something there in the coming months. Yes, there's an array of companies in the EU. We're kinda 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 to 2023, 2024. As far as the Netherlands, we're still focused on the Netherlands. As you know, all the export out of Canada is for medicinal purposes. You cannot export for rec, even though a lot of the strains are the same. With the Netherlands being the first rec market, the two first large rec 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 2024.
Got it. That's it for me. I appreciate the call.
Thanks.
Thank you. One moment, please, for our next question. Our next question will come from Eric Des Lauriers of Craig-Hallum Capital Group. Your line is open.
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. Could you just, you know, 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 wanna give that sort of detailed information, maybe just, you know, remind us what percentage of that Texas footprint this facility was, and just maybe your overall thoughts kind of going forward with respect to the divestiture. Thanks.
Eric, this is Steve. That facility is 30 acres. We're currently growing on 10 acres based on our current consumer demands or retailer demands. Based on that footprint, growing in a third of the greenhouse, it's not our most efficient Texas operation, currently, and one of the reasons that, you know, we've made the decision we've made.
Yeah. We're one of three growers who grow a specific crop in North America that's licensed. I won't mention what it is. That's been predominantly the crop grown there. That seed company has decided they're not probably gonna be looking at developing resistance in that. We're not sure we're gonna actually be in that crop going forward, and that was predominantly what was grown there. We do have the capacity, as I said, in our other locations where we have over 100 acres, and that's expandable. Probably not gonna elaborate more today on that.
Could you perhaps help us understand which will have a greater cost impact on the produce business, this divestiture or some of those tech, you know, technology and innovations that you guys are implementing?
Yeah. Well, we've gone more AI in our growing system. It's proved out really well. We spent about one year on one of our facilities. Now we're bringing it to all the facilities in Texas and probably looking at Canada. One of the things we bet on, if you look at the, my comments were really tied to how do we look at the U.S. market. When you look at the success in the Canadian market, taking existing assets that were used for produce and converting them to cannabis, we were able to do that, I think, better than anyone else because building a new facility from the ground up, besides the huge capital costs today, can take three to five years to ramp up.
I think if you look at the Canadian landscape today, going back over five years, you'll see that there's been a tremendous difficulty in many companies who are new to, not just new to the agricultural industry, but have brand-new assets. It takes a tremendous amount of effort to get to a point of operational excellence where you're generating profitable outcomes in training your people and ramping them up the attrition rate, understanding the tool, understanding the climate. When you have an existing facility with tremendous climatological data that you can rely on, a very experienced team, not just at the grower level, but all the way through the organization, that ramp-up is compressed, and that resulted in us being able to grow organically.
When we look at these assets in Texas, again, we believe that they eventually will be interstate commerce, and that the model in the United States today, to a great degree, is an experimental model that will change upon comprehensive legalization, that we would be in a very strong position to win large scale, low cost, high quality. That's why, again, we, you know, we've kept our optionality, not just for Texas, but for the U.S. market. This asset for cannabis would probably be the last one we would ever convert because it's outside of the main hub of our assets. That's one of the reasons we've decided to reduce this asset.
Cost savings going forward, one of the biggest hits, as I mentioned, was the control of the virus. Resistance is being built in. There is somewhat some level of resistance today in the varieties, and I think there'll be comprehensive resistance in all the tomato varieties. You know this virus has affected tomato growers all throughout the world by 2025. It is being solved. I mean, the virus will be no more eventually, but in the meantime, we have these protocols.
The point I wanted to mention is when we thought we had optionality on some specific assets in Texas that we would convert, we didn't spend a lot of our normal capital in those assets because it would just be sunk costs on a conversion to another crop, in this case, cannabis. We've made those corrections now since we don't know what the future holds for federal legalization in Texas. We're back to focusing on our yield, operational excellence that we've had, customer assessment. We think a combination of those attributes will start to drive positive results on fresh. Not to mention, always looking at alternatives of what we can grow. I mean, we are a controlled environmental agricultural company, and we have the ability to excel in many different crops as well.
That's helpful. Appreciate that color. Last one from me here. Just wondering if you could talk about the impact that implementing dry hanging has had on your overall various different brands. Then I guess specifically on cost as well, I mean, I was surprised to see Canadian Cannabis normalized gross margins expand to, you know, 40% in the quarter. I would have thought that dry hang would have perhaps, you know, had a, you know, negative impact on cost there. Could you just kind of talk a bit more about the overall implementation of the dry hang now? Are we perhaps gonna see more of that inventory in 2023 and we'll see that drag there?
Are you just seeing, you know, such strong sell-through, with that, you know, sort of differentiated product here? Thanks.
Yeah, Mandesh, you wanna answer that?
Yeah. Yeah, here. The hang dry process we rolled out in totality across the entire operation, spring, summer last year. At this point, I mean, all of our inventory that's been hitting the market over the last, you know, at least quarter or two has been hang dried. 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 was 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. Consumers and budtenders and store owners across the country have been wowed.
Seeing that across our entire portfolio from Fraser Valley Weed Co, 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. We're definitely seeing that in market, and we're grateful for that. On the cost side, 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. We kind of, you know, at somewhat at some level, we're cost neutral. It was really about total cost of ownership. When you're, you know, running a facility like we are, there's a lot of different pieces prior to hang drying, which we were doing on rack drying, where we were drying on trays.
There's a lot of cleaning, there's a lot of kind of moving parts that you have to maintain. When you go to hang dry, yes, you're spending more labor and time to get the plant kind of 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. That's just the other part of our nature, is we're always gonna be looking at ways to improve our cost structure and margin profile. 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. 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 kinda strong and one of the best, if not the best in the industry.
That's great to hear. Great execution, and, thanks again for taking my questions.
You're welcome.
Thank you. One moment, please, for our next question. Our next question will come from Pablo Zuanic of Cantor Fitzgerald. Your line is open.
Good morning, everyone. look, the first question.
Good morning.
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. The second question, can you remind us in terms of your plans in British Columbia to convert more of your tomato greenhouses to cannabis? I mean, I hear more companies going asset light. You have more demand on the wholesale side, you continue to gain share on the branded retail side. Just an update on that, please. Thanks.
Okay. I'll answer the second one, Pablo, and then hand it over to Mandesh for the first one. I mean, we're not going to. We have our third greenhouse, which is directly adjacent to our other two that are in cannabis, is that footprint is bigger than our two cannabis greenhouses combined. We're all about retail, building our brands and retail and export. We wouldn't make a capital investment to convert that greenhouse for B2B. It's just not where we wanna be. Long term, it would have to be where we felt we were gonna gain market share. If we converted that greenhouse, we would have enough capacity for 35% of the domestic market in Canada. With imports ramping up, it is something we can do.
By the way, in that facility, which is broken down into two parts, we can actually do one which we couldn't do years ago based on the legislation for Canada early on, where you had to be a single crop. That's, that's where that change would happen if it did. Mandesh.
Yeah. Thanks, Michael DeGiglio. Pablo Zuanic, on your question about the OCS announcement. The OCS announced kind of two main things. They said they're gonna be going to a fixed markup, and they're reducing some of their margins or making them consistent. The announcement they made was that it was gonna have about a $60 million impact to the dollars at OCS, and that was kind of their view. Some of the details are still forthcoming. There's a webinar that's gonna be occurring where more details are gonna be shared. My understanding is those changes are gonna be rolled out later this year. Again, understanding is it's gonna be up to the producer to decide how that giveback from the OCS impacts MSRP.
I think that it's gonna have a meaningful impact on an annualized basis to any producer who has meaningful share. If it's a $60 million impact to the OCS, they're gonna be giving back in margin, and let's just say you have a 10% share, I mean, that $6 million is gonna be coming back to your margin profile or thereabout kind of on an annualized basis. I think we're excited by it. I think it shows a leadership position in OCS to look at where the market is and understanding that their margin and markup profile was on the higher end of the boards, and they know everything that's been happening in the market with excise tax and the overtaxation. I applaud OCS for the move. I think it was great that they're looking at that.
It's gonna be up to the producer now, are they gonna invest in price or keep the margin? That's kind of where it stands, and we're excited by it. We think it's the ability to kind of do both, invest it where we need to or taking a sharpen our pen on pricing. We believe it's gonna be a margin pickup for ourselves and others in the industry.
That's good. Thank you. That's very helpful. Then just to follow up, Mike, you know, any lessons from the CBD deal, right? I understand the market has, you know, worked out for many people that made investments there, so you're not alone. Were you able to leverage your distribution capabilities on the produce side to improve CBD sales? Just lessons, you know, I guess, I don't wanna call it a postmortem, but in terms of where are we there and what's the outlook. Then a very.
Yeah.
-short question regarding the Texas optionality. I get the idea it's always been about in the future interstate commerce. 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.
Yeah. Well, you know, I guess I could self-incriminate myself saying we believe some of the Washington politicians, 'cause when you look at CBD and you talk to the consumers of CBD in the United States, it's astounding how many people have made CBD products part of their life. I'm not just saying that 'cause we're in the industry. It's clear. The problem is, we couldn't leverage our, you know, great relationships on retail because the retailers are waiting for FDA clarity. FDA is in the pockets of pharma, in my opinion. Until, as they've admitted, until there's an act of Congress clarifying the consumption issue with CBD, then the retailers are not gonna take it on. We do have some retailers that take it on that are bold enough, that realize that it is a very...
You know, we have a human endocannabinoid system which most people don't realize. We don't have, you know, a broccoli system. We have an endocannabinoid system, and it works very well for many, many parts of our being, so to speak. It will come, and Washington is really the problem. I alluded to that in my calls. It's not just a problem when it comes to comprehensive legalization for recreational cannabis, but certainly for something on the health side. We consider our CBD a health and wellness. It's under the e-envelope or the umbrella of cannabis, but at the same time, it's really targeted at health and wellness, and it does wonders. We really have to wait till our politicians get their act together.
I think we very much feel that CBD will be a huge consumer product once that FDA clarity comes. That's where it is. On the optionality for Texas, look, I think we've proven Our business model, I believe that our business model has been proven out in Canada, and that's the same model for the US. If you look at, you know, Washington State, California, they're already trying to push interstate commerce. It's gonna happen. I'll make the bold enough statement to say that, you know, if you're in a major indoor grow in the northern part of the USA, the time will come when it's not a question of producing good quality, it's a question of producing good quality at the right price.
You could see what a disaster it is currently with pricing compression and what's going on. Assuming that there'll be clarity in the U.S., then it's gonna go to large scale, low cost. Those existing assets. Yeah, we've taken a hit last year, but our intent is to be positive on our fresh business and keep that optionality. Because to create that will cost hundreds of millions of dollars of capital and years to ramp it up, not to mention getting the talent that really makes Village Farms different than others. We're gonna try to stick to the plan, but not costing, you know, but not losing money. That's really where we're focused. Now, that being said, we also have other entry points for the U.S. I'm not gonna mention where, but we like a regional place.
We don't wanna be everything to everybody. We're constantly looking at an entry point for 2023, 'cause we're kinda getting fatigued of having our hands tied behind our back by Nasdaq and the lack of Washington support.
Given that you brought it up, Mike, and I don't wanna take up too long here on the call, but, so are you saying that you would consider like Canopy Growth, the listing from Nasdaq, and just listing in the TSX to be able to enter the U.S.?
Well, I will say this, that 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.
All right. Thank you.
Thank you. One moment please for our next question. Our next question will come from Michael Freeman of Raymond James. Your line is open.
Hey, good morning, Mike, Steve, Mandesh, and Ann. Thanks for taking our questions, and congratulations on making material steps to tighten up the fresh produce business. This is really encouraging. My first question is on international business. You started shipping into Israel during the first quarter. I wonder if you could describe give us a picture of volumes and how you expect cannabis segment revenue to be impacted by international sales during the first quarter and then looking to 2023 in general.
I think overall, we, you know, we feel pretty good this year. We budgeted probably about sub 10% of our revenue going international for 2023, specifically Australia, Israel, Germany, and England. We think that's, you know, that's kind of where we're looking at. It could be more, but we wanna be a little more conservative because again, it's a regulatory process. Getting things done for this product, as far as having each government working together, import permits and so on, is a tedious product. It takes a tremendous amount of effort. But that being said, the margins and the tax structures are excellent everywhere we're going. It actually will return our highest margin over our domestic sales anywhere in Canada. That's sort of our plan this year.
We have a team that we're building specifically to look at the entry points in a number of different countries over the next two years. That's again, outside of our participation in Netherlands. I'm very bullish on the Netherlands. It's really our first footprint with physical production assets in the European theater. We, you know, our roots stem out of the Netherlands, greatest respect of the greatest producers of food in the world, best agriculture operators, and we think we'll have a great point to leverage up, a great opportunity to introduce brands even from Canada, look at brands in the Netherlands, understand consumer insights across Europe for really a lot of growth over the next decade.
Okay, great. This is a nice new chapter. 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. Very quickly, when were the price increases implemented on the certain products in Canada?
Okay, Steve will answer the first part and Mandesh the second part.
Hi, Michael, it's Steve. With respect to the inventory write-down, you know, it was older inventory, aged inventory, at year-end roughly greater than 15 months old, lower potency and smaller buds. We essentially wrote it down to, you know, what the current, you know, market pricing is because that's what we're required to do. We have been selling that product. It's not that it hasn't been selling. We just wrote it down to the market price and some of that will go into, you know, like the smalls will go into pre-rolls. It will be sold, you know, over the course of time, and it's more just driven by the current market pricing for your comparable biomass inventory in the Canadian marketplace today.
I would also say that if you really look historically in Canada, our write-downs on inventory have been, I think very low compared to most of the other part of the industry. Mandesh?
Yeah. Michael, your question was around the timing of the price changes. We've started to roll those out now, depending on region, they'll be executed over the next quarter or two.
Okay. to be clear, did you implement these at the start of March?
They will start rolling out this month. That's correct. Sorry, you cut out for a second. Yes, they'll be starting to roll out this month and then ongoing pending on the region.
Okay. Okay, great. Thanks for your time.
Thank you. One moment please for our next question. Our next question will come from Andrew Partheniou of Stifel GMP. Your line is open.
Hi. Good morning. Thanks for taking my questions. Maybe going back and diving a little bit deeper into something some talked about previously. First on the Permian divestment and how that could impact your cross profile and produce. You talked about it's one-third of your footprint there, but you also have Delta 1. On the other hand, understanding that produce is a very heavy fixed cost business. You know, 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.
You know, without the Permian dragging on results, given that, you know, you were almost achieving positive gross margin in this quarter, could we see positive gross margin at some point next year?
Andrew, this is Steve. The fourth quarter's gross margin was primarily impacted by Delta 1 with the Brown Rugose. As you said, it's fixed cost business, that crop is now over. Those crop costs flushed 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 production in Q1, the Texas operations did have positive gross margin in Q4. The negative gross margin sees 100% due to the Brown Rugose impact on the Delta 1 facility.
Sorry, I was on mute there. Thanks for that. Maybe going back to your production on the Canadian cannabis side, understanding that, you know, 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 it all? Have you thought about adjusting your production either upwards or downwards? It seems like there's two different things happening, right?
You've got a little bit of a inventory write-down here. You also have the choice that you've taken to increase prices, versus maybe, you know, balancing that out with increasing production. Just trying to, you know, put it all together and get a big picture here. Thanks.
Yeah. Andrew Partheniou, the inventory write-down was not in our inability, capacity-wise to sell. It's the market has changed. Like, if you look at THC levels that consumers want in the last five years, they've changed dramatically. As consumers are changing their needs, we have to adapt to that. You know, it's still agriculture. If you, if you look at the perfect strain and the perfect THC level and the perfect shape and all those attributes, it just doesn't happen in growing a crop. Again, if that's not a product that we wanna put our name behind retail. As Steve said, we can put that those products into other offerings, we'll do that. It was really writing down the price in that regard.
As far as capacity, we started with Delta 3 1.1 million sq ft. Then we started with our next greenhouse Delta 2, which is a mirror image of Delta 3. We went to 50% capacity, never greater than that. We still stand here today at full capacity on Delta 3, 50% on Delta 2. We purposely did not increase that. We felt comfortable where we're at because of our international, you know, our goal to expand internationally. The reason we felt confident is because when we look at our ability to at our production costs domestically in Canada and our ability, as you know, when we launched retail a couple years back, we launched at 31% under the next highest LP for the retail market.
Not to undercut them, but to compete with the illicit trade, that was the price point. We think it's, you know, we think we have a huge advantage in our costs. We're gonna use that same philosophy internationally, because again, as Mandesh alluded to, we're not always first to the market. We weren't first to the export market, but we wanna ramp it up. We think that additional capacity, happening in 2023 and 2024, we feel very confident where our current production levels are. Mandesh, you wanna give any color on that?
Yeah. Hey, Andrew. Good question. Every month, we assess kind of five, six months out, because of the crop cycle, what we wanna 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 about what you can grow, it's about what you can sell, and you wanna, you know, align those two as best you can. Right now we are running, like Mike said, the facility and a half. It's running at full operation, full tilt right now. We're heading into some of the best growing conditions all year, just kinda given the spring, summer months. It's arguably some of the best conditions we get in terms of yield and results.
We're hitting that peak right now. We're constantly evaluating it. We're 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, and we like where we sit now. The pricing and adjustments, yes, we're driven by how we're seeing demand go, and we just believe there's an opportunity for us to improve our margin profile. It's not really meant to kind of 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 use extra production planning capabilities for international sales that are starting to ramp up.
Yeah. I would just one other thing. I mean, we're, you know, 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 wanna make sure that we have insurance, that we always have enough capacity to meet the demand too, so.
Thanks. If I can just ask one more follow-up on this, on this question here. Understanding that you still have, you know, the other half of Delta 2, what would you like to see before you decide to turn on the other half of Delta 2?
Andrew, this is Steve. We would like to see a change in the excise tax regime. We're paying the government, if you look at the difference between our gross and our net, that's excise tax on our stated results. We're paying them way more money than we're paying all our Pure Sunfarms employees, plus, plus.
It's, you know, as others have written on social media and in the press, the excise tax regime as it's currently working is a money maker for the government, and it's very difficult on an ROI basis based on current interest rates if you look at our net cash return at the Canadian cannabis business, which you can do the math and it just wouldn't pencil on the current excise tax. We'd love to, but not with the current tax, excise tax regime in place.
I would add that, you know, we most of the capital costs needed to put the second half of Delta 2, we've already spent that money. It wouldn't be a huge burden for us to put that in production. We're not really looking at a return on invested capital since we already have it, and it was worthwhile doing it all at once. You don't wanna remobilize and, you know, it's cheaper to order all the equipment you need for the conversion. We can do that. International ramping up could be, you know, if international triples, that could be a catalyst for us because as we've said, there's no excise tax and the margins are much higher. For the situation in Canada, it's just hard to justify.
All right. Thanks for that. I'll get back in the queue.
Thank you. 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.
I just wanna thank everyone for participation today. We feel very confident for 2023 in the direction we're going. Thanks for participating today, and look forward to chatting with everyone in May. Thank you, Chris.
Welcome. This will conclude today's conference call. Thank you all for participating. You may now disconnect and have a pleasant day.
Thank you.