Village Farms International, Inc. (VFF) Q2 2019 Earnings Call Transcript

VFF earnings call for the period ending June 30, 2019.

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Motley Fool Transcription
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Village Farms International, Inc. (NASDAQ:VFF)
Q2 2019 Earnings Call
August 13, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen. Welcome to Village Farms International second quarter 2019 financial results conference call. Yesterday, after market close, Village Farms issued a news release reporting its financial results for the second quarter ended June 30, 2019. That news release, along with the company's financial statements are available on SEDAR and 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 on how to access the replays are available in yesterday's news release. Before we begin, let me remind you that forward-looking statements may be made today during 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 our various security filings, including Village Farms current annual information form for the year ending December 31, 2018 and MD&A for the quarter ending June 30, 2019, which are available on SEDAR. These forward-looking statements are made as of today's date, and except as required by applicable securities of law. And we undertake no obligation to publicly update or revise such statements. I would now like to turn the call over to Michael DeGiglio, Chief Executive Officer of Village Farms International. Please go ahead, Mr. DeGiglio.

Michael DeGiglio -- President & Chief Executive Officer

Thanks, Jeanette. Thanks, everyone for joining us both by telephone and internet today. Joining me for today's call is our chief financial officer, Stephen Ruffini and the attendee for the call. We'll start with a review of the excellent Q2 financial results for Pure Sunfarms, which contributed to one of the best quarters in recent memory for us here at Village Farms and provide an update of the steady progress of our US hemp CBD initiatives. Steve will review our Q2 financial results in detail, return with some closing thoughts, and open it up to Q&A at the end. So, starting with Pure Sunfarms and our Q2 results, let me just say, as always for us, we will go straight to our results without deflection no matter what they are. We're not gonna start out by some of our competitors who seem to talk about opening up a small dispensary in Timbuktu somewhere. And we're proud of our numbers.

So, also, I want to dedicate this quarter, if there's such a thing, to our villagers, our core group of loyal shareholders who've been unwavering since we entered the space and have supported the company and believe in our ability to lead the cannabis industry in Canada long and strong to them. And now the results. And if you'll just humor me for a minute, when I received these results draft numbers about 10 day days ago, some of you -- I was in the navy for about 26 years with my active reserve time. And when we did off the candidate training with the baddest marine corps DIs you can ever imagine, everything you did was wrong. But toward the end, if you did something right before graduation, they used the term, "Looky looky here." And it's funny. I hadn't thought about that for many decades until I saw these numbers. And we were very proud of the performance of our Pure Sunfarms team. So, looky here at these numbers.

That's how we're gonna start. And bravo too to all the team members at Pure Sunfarms and Village Farms with these great results. Okay. So, let's start with the results under concept of Delta 3 still being in production wrap-up during this quarter as the two remaining quadrants were only planted out in April. As we announce Delta 3 reached full production on schedule post-Q2. And I'll discuss that in a moment. Total sales in Pure Sunfarms for Q2 and a lot of the numbers I discuss here are before Village Farms' 50% share. They increased 125% sequentially from Q1 to $32.4 million in Canadian dollars. I wanna note here that Pure Sunfarms continues to wait on its license amendment permitting sales directly to provincial territorial and other retailers. Q2 sales were almost entirely the other licensed producers. So, we realized somewhat lower pricing than we expect to achieve selling directly to providences in the future. For competitive reasons, I won't be providing specifics around the selling price.

But I will note that spot market demand remains strong. And spot market pricing continues to be attractive. And Pure Sunfarms continue to sell everything it's producing. With respect to the cost of production, from day one, we have stated our belief that Pure Sunfarms can be a low-cost producer in Canada. And the Q2 results are now providing us with the continued confidence here going forward. All in all, cost of goods sold were $0.65 per gram in Canadian currency. Again, that is all in production costs. That's down meaningful from approximately $1.35 in Q1 and works out to $0.82 for the first half of the year. Steve will provide more context around this number when he discusses the financials. You've heard me say that in the end, the only production cost that really matters is on the last day of the fiscal year. And that's due to variations that are seasonal. While I believe this is still the case, giving the intense focus on this metric by our competitors, we are providing it now for additional content for the market.

As the Canadian markets develop and mature, it's become increasingly evident as we have said all along that being a low-cost producer of high quality, safe cannabis will be a significant advantage. Drivers primarily by the lower cost of production, Pure Sunfarms' growth margin for Q2 expanded significantly to 84% from 65% in Q1. Q2 marked the third consecutive quarter of profitability for Pure Sunfarms. And that's third consecutive quarter of sales and profitability. That's every quarter since our first full quarter of sales with total net income, again, before Village Farms' 50% share increasing 226% sequentially to $37.2 million Canadian. And finally, total Pure Sunfarms EBITDA, which most notably excludes the benefit of the change in biological asset increased 194%, again, sequentially to $25.29 Canadian dollars. That equates to an EBIDTA margin of 78%, an increase of 1,900 basis points from an EBITDA margin of 59% in Q1 of this year.

I wanna be clear that this is true profitability based on cannabis production and sales of only cannabis products. There is nothing in these numbers artificially inflated to cost of this quarter. Pure Sunfarms Q2 financial results clearly rank among the largest, most efficient, most profitable license producers in Canada. That was our initial goal before we continued on to other initiatives including brand strategy and product development. In fact, Pure Sunfarms remains one of the few major license producers in Canada report profitability, let alone consistent profitability. And I wish to reiterate my comments about this on our last call. Based on my 30-plus years in the business, achieving profitability this quickly while still in production is a great achievement. But it's not luck. The harder we work, the luckier we get. But on the other hand, this is based on experience and know-how and everything we've communicated recently in driving these numbers.

For us, the Village Farms, Pure Sunfarms Q2 operational financial performance and achieving such levels in just 24 months since Village Farms first announced our intention to enter the cannabis space in Canada is all the more satisfying because we see it as a clear validation of a differentiated strategy, a strategy that was dismissed by many when we first announced our intention to enter the space. Village Farms has dealt in best-in-class cannabis operation, evidenced by these Q2 results. We have achieved this with a foundation of exceptional assets and the understanding of the value of converting existing high-performance greenhouse operations with decades of sight-specific operating history, years of chronological data, and most importantly, an established and trained labor workforce. Village Farms transferred our own exceptional growing and operation of personnel to Pure Sunfarms.

And we have continued to play an integral role to support Pure Sunfarms' success and added the exceptional senior manager and our CEO, Mandesh Dosanjh and his team that he's building to drive our product and branding strategy, process and product development, and all downstream verticals. It's quite a team and very impressive. And Village Farms has played, again, an integral role throughout our three decades of experience in large-scale, low-cost decision agriculture to bear. We were disruptors. In fact, when looking for a partner in entering the space to help us expedite licensing process, we carried down a number of large producers as partners, names you would well recognize because they didn't share our vision on the way to grow and the cultural side.

Today, just two years later, Pure Sunfarms has not only caught up to the rest of the industry but has propelled itself past most of its peers in terms of production and capacity, sales, and production costs and consistent, meaningful profitability despite most others having a significant headstart, many, many years, some even as much as nine years, and having spent tens or even hundreds of millions dollars more to start up their operations. Pure Sunfarms has set a new bar for the industry going forward. We very much look forward to Pure Sunfarms building on a success in a number of value-driving milestones throughout the remainder of 2019 and 2020. As we announced at the beginning of July, subsequent to the quarter and year-end on schedule, Pure Sunfarms achieved its full run-rate production at 75,000 kilograms annually, which should be reflected in higher production sales volume for Q3 and Q4.

We're very proud to note that Pure Sunfarms Delta 3 facility is the first and only single site fully operational cannabis facility in the world in excess of one million square feet. According to Health Canada data as of March 31st of this year, Pure Sunfarms' 1.03 million square feet represented 14% of the current cultivation capacity in Canada, tied for the largest in the country. Earlier, I mentioned license amendment. Some refer to it as a packaging license, that it will now allow Pure Sunfarms to sell dry cannabis products directly providential and private retailers in Canada. The process has taken longer than expected. We filed in December of 2018. And while frustrating, we respect the tremendous workload of the folks at Health Canada these days. To our understanding, Pure Sunfarms has met all Health Canada criteria regarding the amendment and continues to prepare for sales and distribution to the Ontario Cannabis Store, which it has a supply agreement in place. Expect to realize higher selling prices going forward.

Pure Sunfarms is also actively engaged in discussions with other providences around sales and distribution with plans to rapidly expand grounded sales well beyond Ontario. Yet another opportunity for sales and earning growth going forward at Pure Sunfarms is evolution of its product offering, most importantly, the addition of oils and other derivative products. Pure Sunfarms is making steady progress on a 65,000 square foot state of the art process that are located within the Delta 3 facility. The processing center, which will include on-site extraction capabilities and design for full GMP compliance and certification and remains on schedule to be completed by the end of 2019, in operation as soon as possible, thereafter subject to Health Canada licensing. I mentioned earlier that pricing in the spot market remains quite favorable.

Recently, Pure Sunfarms has been benefiting to an even greater degree as Emerald Health Therapeutics within Pure Sunfarms has a supply agreement onto which it committed to 40% of Pure Sunfarms' output has, since the last part of Q2 been electing not to fully exercise its right to purchase 40% under the agreement. Pure Sunfarms is committed to and has been selling all outfit that Emerald committed to. But it's not purchased to other licensed producers in the spot market. This is clearly beneficial to Pure Sunfarms. And it's realizing a price and a spot market in excess of the predetermined selling prices to Emerald and the supply agreement. As a reminder, the supply agreement -- this particular one concludes at the end of the year when we transition to a new agreement for up to 25% Pure Sunfarms' production and prevailing market prices.

The unmitigated success of Pure Sunfarms today gives us tremendous amount of confidence as Pure Sunfarms moves forward with the conversion of Delta 2, the next 1.1 million square foot sister facility to Delta 3, which is expected to, at a minimum, double Pure Sunfarms' production output. Conversion of the external infrastructure at Delta 2 is now under way. All design and planning has been completed. And mobilization of equipment and all the technologies we need to start the process is on site. And we expect to start pulling the first half of the current crop in two weeks and start an internal conversion. Delta 2 should begin contributing revenues as early as Q2 2020 next year and be operating at full run-rate of production with an additional 75,000 kilograms minimum in Q4, taking Pure Sunfarms totally to at least 150,000 kilograms next year.

As we did with Delta 3 facility, personnel from the existing Village Farms' growing maintenance teams and most critical skilled labor force will be transitioned to Pure Sunfarms December 1st. Those who are regular to these calls have often heard me speak often about the necessity of a best-in-class growing operation to build an exceptional agriculture product brand. That was our goal for Pure Sunfarms. And I'm proud to say that we have achieved that goal. Pure Sunfarms is a best-in-class growing operation. It provides the requisite rock-solid foundation upon which Pure Sunfarms can build a differentiated market-leading brand and so forth.

New hires under Mandesh's leadership brought in deep CPG experience on board VP of ops, Mike Lattimer out of Labbats, Honda, PwC, Maria Guest, VP Brand Commercial already had a year or so in cannabis and 12 years of AB Inbev and Labbats, which is land sweeping quality, 14 years now through health products and three former companies. Zach Barr, Director of Production, 12 years at Pepsi and so on. Adam Patterson, Spot Supply Chain Director, previous in cannabis, 10 years retail CBD companies. David Satite. So on. And Bill Hayer, Director of Engineering. Great mechanical engineer. Ran his own firm. These are just a few of the key executives that are on board Pure Sunfarms recently and now will take the company to an even greater level of profitability, I'm sure.

Turning to United States and the hemp/CBD business, to our US hemp program where, as a reminder, our goal is to build a vertically integrated consumer packaged goods company growing, extracting, producing our own CBD products for big box retail market. On our last call, I talked about our aggressive pursuit of this huge opportunity. We announced it right after legislation was passed in December, purchased $2.5 million worth of seed and went to work with a great, great partner informing Village Field hemp for outdoor cultivation and CBD extraction in the southeast of the United States to start with. During Q2,w e took two additional major steps forward. First, we expanded our outdoor hemp cultivation program to Colorado through a joint venture with Arkansas Valley Green and Gold Hemp. That's the name of the company for the excellent growing area that's located adjacent to the Arkansas river in southern Colorado.

We have an outstanding partner there as well who is the founder of one of Colorado's largest licensed outdoor cannabis growing operations. Arkansas Valley has already planted out 120 acres to start this year. And we expect to be in harvesting in October. It will have its own on-site extraction operations expected to be operational processing crude CBD oil by early 2020 and looking at smokable CBD flower as well. Our other JV Village Fields Hemp has approximately 600 acres in production in Virginia, North Carolina, South Carolina, which will begin harvesting in the coming weeks with initial sales of hemp biomass to commence in the fourth quarter '19. Village Fields Hemp is now well in advance planning and engineering work on its large-scale extraction operation in Georgia, which will be located in Soperton and serve the southeast US operations. These are also scheduled to be operational by the end of Q1 next year. So, that's about 720 acres total production outdoors for this year.

Second major milestone with the legalization of hemp and CBD in Texas. We move forward in earnest our greenhouse hemp cultivation program and started conversion and advancement of half of our 1.3 million square foot ultra-high-tech permanent base and greenhouse cultivation extraction. So, we plan to start growing, extracting as soon as possible. That just sets up regulatory framework. And we can obtain the requisite licenses. So, we're waiting on Texas. And with Texas, waiting on the USDA as all the other states that were not approved under 2014 still are. We are off to a great start with our hemp and CBD programs. We're building a rock-solid foundation, exceptional growing operations as we did in Canada with Pure Sunfarms that will enable Village Farms to build an exceptional brand in the CBD market. Hemp biomass sales will start this year. CBD crude sales will start early next year.

And then we'll move to production of branded and white label CBD products formulation to existing model to national big box pharmaceutical companies, grocery companies, as well as other retailers throughout the country. So, with Pure Sunfarms, numerous milestones throughout this year and next to drive growth in revenue profitability in the USA. There's a considerable opportunity. And we are doing a lot of work in the backgrounds of sport house strategy. We're very active in moving forward quickly in R&D and a number of areas including genetic seed, development of advanced growing techniques for greater plant health, and working with a number of universities in that endeavor. Plant health is key. And I would say that's probably at the top echelon of why we're successful. Cannabis a very nascent industry, as we all know. And the tools available for our growing operations are not there maybe years before the regulatory process allows that.

So, integral with keeping your plant health up. And I firmly believe that with solid plant health, you can avoid all diseases, including mold, which many don't believe. So, enough of that for now. To conclude, Pure Sunfarms is indicative of the value of our strategy to pivot toward new, outsized growth opportunities and transform the earnings potential of Village Farms. We are only able to capitalize in these significant high-growth opportunities in cannabis and hemp and CBD because of the organization's strength and know-how we've amassed is one of the largest and longest operating greenhouse growth produce businesses in North America. As I have discussed on prior calls, produce business has been challenged in recent years, primarily due to imports from Mexico, which have significant labor cost advantages. We are pivoting with this business to moving production in Mexico, as we try to send off America greenhouse and assets of cannabis and hemp toward significantly better economic returns.

There'll be some short-term pain. But it'll be long-term gain in our produce business. We work through this transition. We've already increased some of our sales 18% this quarter out of Mexico as we start to replace that capacity like Delta 3 and soon to be Delta 2 and the Permian Basin facility. And you can see that in our results. But our produce business will emerge significantly stronger down the road, more competitive, and more valuable. And clearly, financial returns and the shareholder value both short- and long-term that are being generated by our transition to cannabis and hemp are worth it. Now I'd like to turn the call over to Steve who will walk you through our financial results. Steve?

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Thanks, Mike. Just to touch on each one of our business lines, produce, hemp, and cannabis relatively quickly, first, produce. Obviously, we are disappointed with our produce results. A gross loss on the quarter of $3 million is obviously disappointing. It is not the first time. last time we had a gross loss in the quarter was in second quarter of 2012, as a result of a hailstorm, which ended the Texas crop rather quickly. In this particular instance, we've had -- as we've said, we've transitioned one of our greenhou -- started transitioning one of our greenhouses. So, that crop has been pulled. Obviously, maintaining our labor force, etc., is extremely important. So, those costs just hit our cost of sold directly. With respect to the other Texas greenhouses, they have had various pressures throughout this growing season. And the crop did not end well. As we've talked about in the past, most of our costs are fixed. We're trying to spread our crop over the full crop year with respect to the crop.

When the crop doesn't end well, essentially, you accelerate those costs down to zero on June 30th. So, new crop in Texas going forward, we are looking to get back to a gross profit for the rest of the year with respect to our produce. With respect to SG&A, those are corporate SG&A costs. Historically, we've put those into the produce column because we've had those historical costs. Year on year, our SG&A increased 6%, excluding stock comp. Obviously, a year ago, we weren't on NASDAQ. A year ago, we were a foreign private issuer. We're no longer a foreign private issuer. So, we are spending dollars now getting ready to be fully SEC compliant on January 1st, which includes store-bought. Obviously, when we went on NASDAQ, needless to say our D&L insurance and other costs like that went up on a year-on-year basis. None of those have anything to do with produce. Actually, our direct produce SG&A has come down on a year-on-year basis.

So, the incremental increases folks are seeing in our SG&A are directly related to our new business lines. And that's all I'll say about that. With respect to hemp, not much has happened in this quarter. Relatively, some SG&A cost. That's it. There won't be much in the third quarter either. The initial harvest is expected later in August and September. Obviously, those crops need to be dried. So, the market should not expect any significant revenues, or what have you, or any significant changes in the hemp results in Q3. And when the Q3 results come out, we'll talk about the Q4 expectations in the November. With respect to Pure Sunfarms, obviously, a very, very strong quarter as the market can see. With respect to the strong cost of sales, I tried to indicate and lead the market to that conclusion on the May conference call. I stated on the May conference call that 30% of the Q1 cost of sales were seasonal for Pure Sunfarms. And that is in a form of power, a form of electricity.

Obviously, in the summer months, we don't need that. The greenhouse growing, whether it's us or for anyone else, particularly in Canada will be seasonal. So, you will see lower cost per gram of production in Q2 and Q3 than you will in Q4 and Q1. So, there will be some variability in the gross margin of Pure Sunfarms due to the seasonality of those costs. Part of the improvement wasn't just the seasonal cost. It was the benefit of the ramp-up. As I stated with produce, a lot of your agricultural costs are fixed. So, as you're ramping up, and you're getting more revenue and more volume from the greenhouse, obviously, your cost per gram come down. So, the market should expect the Q3 cost of goods sold will benefit, obviously, from the continued summer production. And the market should expect that those strong costs per gram will continue with starting to see an increase in Q4. Q4 will have some winter production in its sales.

And we'll still also benefit from some of the summer production due to the lag time between harvest and sales and with respect to Q1. Q1 will historically, probably be Pure Sunfarms' highest cost per gram in any given quarter. With respect to the expectations for Q3, as we discussed on the May call for Q1, the leading indicator is the bio asset. As we've done in the past, the full set of Pure Sunfarms' financials are contained in Note 7, the Village Farms' financial statements. If one were to refer to those right now, you would see the bio asset for Pure Sunfarms on June 30th was $36.4 million. That's Canadian. The bio asset at March 31st was $18.2 million. So, that's a leading indicator of the third quarter being significantly stronger than the second quarter results that we've just reported. And with that, I will turn it back over to Mike.

Michael DeGiglio -- President & Chief Executive Officer

Thanks, Steve. Okay. Just to review and conclude, our Q2 results are clear evidence of common mounds of transformation of the earnings potential of Village Farms. Pure Sunfarms already making meaningful contribution to our financial results. And that business is really just getting started. We expect Pure Sunfarms will deliver consistent quarter-on-quarter growth throughout this year and next driven by Delta 3 at full production capacity, the anticipated start of sales to the Ontario Cannabis Store, the provincial territory on private retails expansion of product sales into pre-rolled and oils and other fitting products, Delta 2 facility coming online next year doubling the capacity there.

We continue to be optimistic about the potential for Pure Sunfarms to exercise the option on the Village Farms 2.6 million massive square foot Delta 1 facility and return and further expand production to as much as 300,000 kilograms or more. Similarly, our hemp and CBD business well-positioned to contribute near-term growth revenue and earnings going into next year. First sales that have biomass later this year. Sale of crude, as I said earlier, followed by our own CBD products next year. Expand our outdoor cultivation next year. Begin cultivation of Permian Basin greenhouses will start in Texas as soon as we're licensed to do so and positioned very well for the move for this massive opportunity USA. So, with that, we'll open up the session to Q&A, Operator.


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Questions and Answers:

Operator

At this time, if you would like to ask a question, please press * then the No. 1 on your telephone keypad. Again, that is *1 to ask a question. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Doug Cooper with Beacon Securities.

Doug Cooper -- Beacon Securities Limited -- Analyst

Hi. Good morning, guys. And congratulations on a great quarter. And Mike, it was a great update. I just wanna focus in on the cost per gram and $0.65 in the quarter. How low do you think that can go as you get more economy to scale through the ramp-up? And I see that a number of Canadian LPs are moving to or bringing on outdoor grow. Can you just talk about maybe how that can compare and what your thoughts are around that?

Michael DeGiglio -- President & Chief Executive Officer

Well, it's kinda funny, Doug. Every time I see a large LP announcing they're doing an outdoor grow, I shake my head because I just don't get it. It makes me think that you're having a difficult time executing on the technology side because to me, in Canada, it just doesn't make sense. Regarding the cost, I think we can drive our costs down. We're not saying we're gonna -- we've always stuck to under a dollar a gram. And we're sticking to that. But clearly, I think our cost can be driven down. And this is on flower more and more.

And of course, that cost will be significantly lower as we move into oil. But we've seen some really unbelievable things based on our years of growing multiple crops. I've seen it. And the team has seen it that it's pretty unbelievable where we think we can go with the right technology. Nothing we talk about now. But I think the possibility is really great in the future to drive costs to phenomenal low going forward. And it's all centered around plant health and processes and growing. So, I actually believe we can compete worldwide even if importation has opened up. But that's not tomorrow. But I can't give you specific numbers. But I think we can still hammer it down.

Doug Cooper -- Beacon Securities Limited -- Analyst

Right. And then maybe just on the strategy side, presumably, the realized prices if you were able to sell directly right now would be a couple dollars higher per gram, at least. But from a strategic perspective, once you got the ability to do so, the cost per gram that other companies have reported thus far are certainly significantly, significantly higher. You mentioned the word disruptor. How much market share would your assets enable you to have? And what would be the strategy to do so? And to that end, you mentioned D1 there, briefly. What is the plans to bring that in? And how quickly can that be done? And if other companies start to have financial concerns -- obviously, we have one out there right now -- would there be assets out there that you would -- if you could buy them at pennies and a dollar, would that be of interest to you?

Michael DeGiglio -- President & Chief Executive Officer

Well, yeah. We always look at an asset if it's distressed. I think there's gonna be a lot of assets that get repriced a couple times over the next couple years. I said a year ago that at some point, we may start the commoditization process because if we feel so confident in our costs -- look, at the end of the day, in Canada, the Canadian government wants to displace the illicit trade. And they're not gonna do that by arresting anybody who's breaking the law. They're gonna do it by pricing the product to be competitive or more competitive than the black market. So, that's gonna set the bar on price.

And then of course, they have to make their profit. And of course, taxes come out. So, at the end of the day, the growers are all gonna have to compete at this price to take out the illicit trade. That's the bar. But if our cost of production continues down, then we could start to come down and push the commoditization. And the first guys I think at or $3.00-plus a gram. And then on the cost of production in the tubes. And take that additional market share. I would get down to $1.00 tomorrow if I could because I know with the cost of that facility now, we have the confidence to be. And I think it'd be hard for anybody to compete with that, especially as we move into more oils going forward because that production cost of flower is much higher than oil. So, I'm very confident where we can go for the future.

Doug Cooper -- Beacon Securities Limited -- Analyst

And maybe just my last question being you don't have -- because it's a wholesale business right now, you're not supporting brands at retail or on the SG&A cost and so forth. Once you get into your own brands -- and presumably, spending has to go up a little bit to do that -- what do you think the long-term EBITDA -- assuming where your costs are and pricing is today. But certainly, the 78% EBITDA margin is eye-popping. And what should the market be thinking about in terms of long-term sustainable EBITDA margins in your view?

Michael DeGiglio -- President & Chief Executive Officer

Well, I would say this sets the bar for the EBITDA margin. So, plus or minus a couple percent because SG&A -- marketing in Canada is not gonna be like marketing in the USA. It's gonna be a whole different venue. It's very controlled. And companies are spending all this money -- the Hollywood crowd, so to speak. You just don't get it in Canada. You're very restricted in what you can do. And Pure Sunfarms is gonna roll out a great branding strategy that's based on the Pure Sunfarms brand.

And it's gonna be really based on the quality of the product we put in the marketplace. But I don't think that cost is gonna really move our SG&A line up because as we double production, the cost -- our overall cost for SG&A is just gonna be driven down even with that initial marketing post. We have a team in place. There's a great team fully in place today. So, I think the EBITDA margin is sustainable. And even if as it commoditizes out, those efficiencies, cost efficiencies that I can see are very real going forward. And I think we could sustain these kind of numbers for the foreseeable future.

Doug Cooper -- Beacon Securities Limited -- Analyst

Great. And just my last one. On the packaging license -- you mentioned it in your speech at the beginning. I know it's Health Canada, and you have no ability to push them. But what is your thoughts now on when this might be delivered?

Michael DeGiglio -- President & Chief Executive Officer

I'm not gonna say because I had talked to when we thought we would receive it. And that was predicated on knowing that we're compliant. And we are. To the best of my knowledge, we've met all the criteria. And it was also based on the time it was taking for other competitors. I can't say what the reason is. It's out of our control. I don't know if it has to do with some of the bad actors out there. CannTrust, these guys should be in jail as far as I'm concerned. And when that kind of stuff happens, I would think if I was working for Health Canada, it would affect my trust in other companies.

And I'm gonna kick up my processors across the board. So, that could be part of what's driving it recently. There's a lot of companies out there that have odor issues because they're located in the middle of a residential area. That's not the case with us. But that's getting traction. So, I think there's a lot of different forces at work. But it's gonna come. And we have everything set up to go. So, whether it's a month or three months, I don't think it's gonna affect our ability to execute very well this year. So, I'm not that worried about it. But I can't say when. I'll leave that up to the government to decide.

Doug Cooper -- Beacon Securities Limited -- Analyst

Great. Okay. That's it for me. Thanks, guys.

Operator

Your next question comes from the line of Andrew Partheniou with GMP Securities.

Andrew Partheniou -- GMP Securities -- Analyst

Hi. And thanks for taking my call. And congrats on the outstanding quarter. I wanted to ask for the Pearson Farms utilization capacity in Q2, can you give us a little bit of color on where that was? And given that in Q3, it's gonna be at full production, could be interesting to see what kind of increase in results that could mean.

Michael DeGiglio -- President & Chief Executive Officer

Well, let's just say it was about half utilization. I know what the number is. I'd have to look it up. But based on the licensing, we picked up a lot of our licenses in a very short amount of time between December and February. And then of course, you have to propagate the plants before you get them to the growing room. So, I think we were about 50%. So, I would probably say that's a decent number to look at between the first half of the year and the second half of this year.

Andrew Partheniou -- GMP Securities -- Analyst

Okay. That's great. Thank you. And you mentioned that Emerald is not taking advantage of its 40% on its contract. Can you give a little bit of color on what kind of quantity they are buying if that's above or below what it's going to turn into at the beginning of next year?

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

This is Steve. It's roughly in line with their 25% for next year. It does vary. You gotta remember Pearson Farms is producing fresh batches every single week. That's what it's designed to do. So, depending on the batch, depending on Emerald's product line, some instances, they're taking the full amount. And some instances, they're taking a lesser amount. But net-net, it's roughly in line with what their new supply room will be starting January 1st.

Andrew Partheniou -- GMP Securities -- Analyst

Fantastic. Thanks for that.

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Again, it's all being sold -- anything they passed on is all being sold at a higher price to other licensed producers.

Andrew Partheniou -- GMP Securities -- Analyst

Right. And you guys are still planning on unveiling the brand at the same time as receiving the packaging license?

Michael DeGiglio -- President & Chief Executive Officer

Yup.

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Yes, that's the plan.

Andrew Partheniou -- GMP Securities -- Analyst

Okay. Great. Transitioning a little bit to the US market, you spoke previously about market segmentation. Maybe you can discuss a little bit on the smokable hemp flower trend that we're seeing now. And given that the Texas greenhouse is probably better positioned for that than potentially a outdoor cultivation, like many people are doing, maybe you can give a little bit of color on how that fits into your strategy.

Michael DeGiglio -- President & Chief Executive Officer

Well, we're certainly looking at that. That's a trend that's coming up. And as we said in early stages of talking about differentiating the market -- just say it's a 90%-10%, 90% CBD growing from hemp in the field versus 10% or 15% from a controlled environment -- that that validation for those percentages will come. And this is an example of a product line that's getting traction that would work very well in a controlled environment just because we're producing four to five crops per year per section for control to keep a quality flower as far as controlled environment versus outdoors. So, yeah. We had touched on that before. And I think that's an area that we're definitely gonna look at going forward.

Andrew Partheniou -- GMP Securities -- Analyst

I find it very interesting given -- I'm not sure how accurate the prices that we're seeing are, but it seems like it's ten times or above smokable flower versus biomass. So, it seems like an interesting opportunity. Given that and also the progress that you guys are making in the US overall, can you give a little bit of color on maybe interest of potential buyers or the prices or volumes that you might be seeing on a preliminary basis for US CBD products?

Michael DeGiglio -- President & Chief Executive Officer

I don't think we're prepared to say that at this point in time. So, I think that's a big part of our strategic focus starting here in September through the rest of the year on exactly where we wanna initiate and play in what part of that space. So, I think it's just too early on, Andrew to comment.

Andrew Partheniou -- GMP Securities -- Analyst

Okay. No worries. And just the last one for me, if I can put it in there is the USDA should be coming out with regulations some time soon. Do you have any little bit of color that you can provide on that as well in terms of timeline?

Michael DeGiglio -- President & Chief Executive Officer

Yeah. Well, I'm really happy about the FDA and their possibility. If they take longer, it's fine with me because that's a lot of Village Farms' -- again, we want brand -- brand rules at the end of the day. There's no doubt about it. And as we look at a CBG pivot here, at least in the US without assets and what we're doing in the field, that branding side is very, very important. But our concept is you gotta get the foundation right on a cultural side.

And it's great to be a CBG company that has no tie to manufacturing or growing in this instant. But we don't see it that way mainly because the genetics have not been developed yet. And that will come. And at some point, it's OK to be purely a CBG company. So, with that said, even when it comes to regulatory processes, that gives us -- if the FDA takes another six-eight months, a year to get it right, that's helping us build this foundation over existing players in the space and are coming out of the existing players in the space that have been producing before it was decriminalized in December. So, we're happy about that. And I think the FDA plays an integral role in regulating the industry. So, we're glad to see that happening. And that they take their time just gives us more time to get our ducks in order.

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Thanks, Andrew. We gotta move on to the next question.

Andrew Partheniou -- GMP Securities -- Analyst

Thanks for your time.

Operator

Your next question comes from the line of Scott Fortune with Roth Capital Partners.

Scott Fortune -- Roth Capital Partners -- Analyst

Congrats, guys on a good quarter. Real quick follow-up on Pure Sunfarms. I know you're expecting the licensing. Can you step us through on the timing as far as the rollout of the brand and then how far along are you in discussions with the different providences outside of Ontario to begin selling it at those providences? How should we look at that?

Michael DeGiglio -- President & Chief Executive Officer

Yeah. We're a way along with the other providences. Just that most of them are waiting until we have the license to commit to a contract. But that dialogue is taking place. And I think it'll happen very quickly after the license. We talk about Ontario because we do, in fact, have a contract with Ontario while they're waiting to see us get our license. So, that's well under way. As far as the brand, the brand strategy's in place and ready to go. Pure Sunfarms has been working all out on that for about nine months. They're ready to go. But I think that'll coincide more or less with the license coming on board. And as I said earlier, I just don't know when that's gonna happen. So, like everyone else, it's out of our control. And every Friday we wonder if it's this Friday.

Scott Fortune -- Roth Capital Partners -- Analyst

Okay. And expanding upon that and the contraction strategy side of things, is there a percentage that you're targeting toward the cannabis 2.0? Step us through near-term extraction and until that slowly gets built out, what's the strategy from that standpoint?

Michael DeGiglio -- President & Chief Executive Officer

Well, we're gonna stay internal because we like to control the vertical all the way through. And I think we can do it at a fairly good cost. We're really shooting for GMP certification on our extraction side so that that market opens up even for exports. Europe, at some point, will be ready to go there. We have everything in place to be able to start extracting by year-end, this December pending on licensing. So, I think next year we'll be rolling forward. And as the market moves, and we bring on Delta 2, I wouldn't be surprised that next year, we could be looking at -- this is somewhere in the 30% range. I think in the future, it could be 50%. But I think 30% is probably a number I'm throwing out there. The Pure Sunfarms team would probably know better. But in some of the conversations we had, that seems to be a number going forward.

Scott Fortune -- Roth Capital Partners -- Analyst

Okay. And then just real quick, on the US hemp side, obviously, the biomech is seeds and genetics for planting next year. Have you guys gone out for purchase seeds? And in a sense, what type of size from a harvest are you guys potentially planning for for the following year?

Michael DeGiglio -- President & Chief Executive Officer

Yeah. We're not putting too many of those numbers out. I could tell you we purchased when there was no seed available back the end of last year. We purchased well over $2 million. So, clearly, it's always on our radar screen to be ahead of the curve. And we do have a number of initiatives that we haven't talked about tied to seed and genetics. Probably don't wanna go there here because of competitive reasons. And I think a lot of folks are clearly working on the genetics. But until such times that the large, multibillion dollar seed companies get in the space -- and I don't think that's gonna be too long -- I think a lot of the companies have to take that burden on. We are too.

We're working with some great folks at some great universities pushing that forward. And the genetics even on the field side have to be tied to critical day length. And if you look at Texas alone as a state, it's like a country. There are so many different latitudes and climates. So, you have to gear those genetics to that. And the same in the greenhouse and looking at percentages of CBD and so on. So, it's an exciting place to be. And of course, it creates IP if you're fortunate enough to hit on something that's the holy grail. And that's a big focus for us. But we are looking at next year. And I think we'll be in pretty good shape.

Operator

Your next question comes from the line of Eric Des Lauriers with Craig-Hallum Capital.

Eric Des Lauriers -- Craig-Hallum Capital -- Analyst

Hi. Great. Thanks for taking my questions, guys. And congratulations. I'm really impressed with Q2. I was wondering if I could just start with margins. Obviously, a great strong point for Pure Sunfarms. A little bit weaker as it relates to produce. So, if I could dig in there a little bit. So, on the produce side, margins impacted by a decrease in production, which with the fixed cost, obviously increases the cost per pound there. So, the conversion of the half the greenhouse in Texas obviously having an impact, Delta 2 as well, could you give us a sense of how much this interim period, especially as it relates to Texas -- we have no produce sales and no hemp sales. Can you give us a sense of how much that impacted your produce gross margins this quarter?

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

This is Steve. It's not insignificant, but it's not that insignificant. We're talking hundreds of thousands of dollars. It's not that significant. The bigger issue is the end of the Texas crop. This year, we had higher expectations. And essentially, you have to accelerate your -- we undercharged ourself on a per pound basis. So, we have to, at the end of the crop -- end of June 30th, that crop's all gone. So, you have to bring all those crops off out of inventory and run them through your income statement.

So, it's really a catch-up for costs incurred in prior periods because the crop is gone. So, on a go-forward basis, as Mike said, the Delta 2 grow team will transition December 1st. They're continuing to grow tomatoes as we talked about in the MG&A. Half that facility will begin conversion at the end of September. So, there will be some incremental overhead cost of goods incurred in the fourth quarter relating to Delta 2 that hit our books that have no revenue to generate against them as, again, we're planning on transitioning the growing team on December 1st, as Mike said earlier.

Michael DeGiglio -- President & Chief Executive Officer

But we can't underestimate the cost. The whole company is pivoting. So, a huge part of our costs is going into a different direction. And the cost of doing that over the last two years has all been -- it's being picked up because we report to them still as a produce company. But these costs are well within a normal SG&A percentage. But at the same time, we would not incur these costs if we weren't investing in a whole new area. We haven't taken a penny of profit or cash flow that's paying for the whole Village Farms team. And a lot of us are supporting that effort within the Village Farms team across every discipline from accounting and finance to R&D to asset development and the whole IT team and so on and then supporting our joint venture partners. That's a significant part of that cost. And to enter your question with -- as soon as we get the license, we're ready to roll. But if that half -- we can't control the USDA. The USDA has communicated.

And they're gonna get the regulatory process right. And if it takes three-four months longer, it is. And Texas can't move to that. But in the long term, it's a great move for us. And the amount of hands -- that is one of the most high-tech facilities anywhere in the world. And we're gonna take it to another bar. This is the time to make some technological advancements that we think will hugely pay off on the cannabis side. And I'm not at liberty to talk about them. But we'll take that time to do it. So, unlike other our competitors that have 110% SG&A costs and have burn rates of losing $300 million a quarter, in a way, that partly outburned the cost. But we're doing it with an underlying business that's supporting it. So, we feel good about that even though it's showing some negative loss to the business.

Eric Des Lauriers -- Craig-Hallum Capital -- Analyst

Got it. That makes sense. And then just one on the retail side of things. As we look at 2020, assuming you have the packaging license and amended sales agreement by then -- so, as we look at 2020 and maybe into '21, how should we think about your target breakdown between wholesale and retail?

Michael DeGiglio -- President & Chief Executive Officer

We kinda touched on that on the previous call. But I think prudently would be around 20% deferential on the pricing because I think we wanna remain -- we're carving out a sweet spot where we wanna be on pricing where we would like to see our products sold. And I think even when you hear about some -- you hear some stories that there's an oversupply. Well, I don't believe that. If you're trying to sell your product at $14.00-$15.00 a gram, there's probably an oversupply. But if it's priced right, it's that every day. And as the team -- the Pure Sunfarms team will launch their concepts and brand, and I'm totally on board with it. But I think that positioning is where it's at. So, I don't think it'd be prudent to say we're gonna see a huge 30%-40% deferential. I think it's probably be more in that 20% range.

Operator

Your next question comes from the line of Aaron Grey with Alliance Global Partners.

Aaron Grey -- Alliance Global Partners -- Analyst

-- on the quarter. The first question's just gonna be on -- you mentioned the spot market remains strong. Just wanted to get some color on where you see that going forward. And then what are you seeing in terms of the overall market supply and demand and when that might reach equilibrium?

Michael DeGiglio -- President & Chief Executive Officer

Well, I think it'll happen. I think looking at the competitive landscape, as we already said, this, at the end of the day, is farming, be it high-tech farming. And farming is not for sissies or the weary, so to speak. It's hard business. And you need to be on your game 24 hours a day, 365, on the edge, pushing it. And you need to keep that plan in balance. And I look at the competitors, and I think sometimes they've taken it -- it's not like any other business. Every business is tough, but farming's real tough.

So, I think that's where experience makes the difference in the know-how and being able to steer that crop and keep it healthy and performing well. It's like a finely tuned athlete. You need to be in your game, healthy every single day. And when you lose that, it affects you. So, I can't answer when the other folks will start wrapping up. They've been doing it a while. So, I would expect soon they're gonna get the numbers going. And so, I really can't say. But our concept is based that everything commoditized in farming, and this will too. So, we're focused on our costs and being able to get a chair at the table when the music stops here.

Aaron Grey -- Alliance Global Partners -- Analyst

All right. Great. Thanks. And just touching again on gross margin, more on a long-term basis. As we look at the puts and takes there in terms of long-term pricing pressure, which seems to be inevitable as you mentioned commoditization earlier, but also upside and novel form factors, and also direct to providence sales makes sure you guys -- how best to look at the long-term gross margin opportunity for the company, at least for Pearson Farms?

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Yeah. Again, we're excited about getting the packaging license. We expect to be able to maintain and improve our gross margin dollars. Our gross margin percentage, because of the $1.00 tax will decrease a little bit. But the gross margin dollars will improve. And as we get into oils and extraction, again, we'll be -- that facility will be up and ready, operational by the end of this year. Obviously, we've got to get it licensed from Health Canada. So, we should see improved margin from extraction and oils beginning hopefully early 2020. And we'll see how the other various cannabis 2.0 develops in the marketplace. Ultimately, we're vertically integrated. We're in control. And actually, extraction-grade is actually cheaper to harvest because we're not dealing with all the post-harvest cost of the bud. So, I think we'll certainly be able to maintain a significant market-leading gross margin in all aspects of all products in Canada.

Operator

And your final question comes from the line of Hugh Cooper with RBC Financial.

Hugh Cooper -- RBC Financial -- Analyst

Hey, guys. Congratulations on the great quarter. I think most of my -- I had a few questions, which have been answered. Just wanted to say that you guys have been the one firm in the industry to under-promise and overdeliver. So, it's been very, very impressive. On Delta 3, you've got -- I managed a tour there. And I noticed that you had a fair amount of office space and a vault and so on. Delta 2 is only gonna have that small extraction processing center. So, you're saying 75,000 kilograms out of each greenhouse. Some of the other LPs have said they're gonna get a lot more out of their greenhouses. Is that a number that is flexible? Or is that a base number? Or are you guys just -- I don't wanna cramp your style, but is that just a base number? Or can you increase that?

Michael DeGiglio -- President & Chief Executive Officer

That's the number we're sticking to, Hugh. Look, I think you just gotta look at the bio asset, which, by the way, we won't be reporting when we switch to US here in another quarter. But it's a great indication. And the possibilities are there. We've seen what can happen. And it's pretty mind-blowing where we think we can take it. But prudently, based on our experience, at some point, things happen. They always happen. It's not a question of if. It's a question of when.

And we wanted to take the prudent approach with the new conversion to this crop and get four seasons under our belt. And it's going very well. So, Delta 2 is gonna have a larger production footprint than Delta 3 as you pointed out. So, right there, there's a pickup gain. So, I think the answer is sure. We can get there. And when others say they can get it, they haven't gotten it. So, everybody's saying what they can produce. But who's doing it so far? We're meeting our criteria because we had realistic goals to set. And I think at some point, we'll update that. So, I hope that answers your question.

Hugh Cooper -- RBC Financial -- Analyst

It does. And just lastly, you've got -- I know you guys have a lot on your plate. But are you contemplating or looking at or have you been to any talks, discussions about joint venturing anything outside of Canada or the US?

Michael DeGiglio -- President & Chief Executive Officer

We can't comment on that. But Pure Sunfarms, we structured the company with the total ability to do whatever it wants anywhere in the world. So, I think Pure Sunfarms with Delta 2 well on its way, it's all planned out. The construction's gonna start. I think the leadership at Pure Sunfarms is clearly looking at opportunities of expansion in the space in a number of areas. They should be doing it. And they are within Canada. And I think it's a very focused group. They're focused on expanding operations in Canada. And I don't mean just production operations but product innovation many different ways. And I think if they get that going and right, then they could probably look at international opportunities separate from Village Farms. And we're totally looking at that as well. So, I think there's more to come there for sure. And as we've always said, let's get the fundamentals right. We wanted to prove that we could make consistent profit, build a sustainable, durable company, profit first, and then go from there.

Honestly, I see companies every day launching IPOs and all based on the CPG pedigree within the company. And these guys are very impressive. But there are a lot of great, talented executives in the CPG industry out there. And any company can bring those into the space because the space is new and growing. But it's not the same to get the fundamentals down on the farming side and the production side. You gotta have the right product to have a good CPG company. So, we see it that way. And proving the profitability is where we wanted to start. And now I think it opens up a lot of opportunity for us both for Village Farms and Pure Sunfarms.

Hugh Cooper -- RBC Financial -- Analyst

Okay. Thanks very much, guys.

Michael DeGiglio -- President & Chief Executive Officer

Thank you. All right. Thank you, everybody. That concludes it. No more questions. And we look forward to reporting in November. And thank you so much for your interest in Village Farms. Talk to you soon. Bye. Thank you, Operator

Operator

This concludes today's teleconference. You're welcome.

Duration: 64 minutes

Call participants:

Michael DeGiglio -- President & Chief Executive Officer

Stephen Ruffini -- Executive Vice President & Chief Financial Officer

Doug Cooper -- Beacon Securities Limited -- Analyst

Andrew Partheniou -- GMP Securities -- Analyst

Scott Fortune -- Roth Capital Partners -- Analyst

Eric Des Lauriers -- Craig-Hallum Capital -- Analyst

Aaron Grey -- Alliance Global Partners -- Analyst

Hugh Cooper -- RBC Financial -- Analyst

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