Greetings, and welcome to the Valens GroWorks Second Quarter 2019 Earnings Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Everett Knight, Executive Vice President of Strategy and Investments. Thank you. You may begin..

Thank you, Operator. Good morning, and welcome to the Valens GroWorks second-quarter 2019 financial results conference call. A replay of this call will be archived on the Investor Relations section of the Valens website at www.valensgroworks.com/investors.

Before we begin, please let me remind you that during the course of this conference call, Valens management may make forward-looking statements. These forward-looking statements are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations.

For more information on the Company's risks and uncertainties related to these forward-looking statements, please consult the Company's MD&A and other regulatory filings available at www.sedar.com. Any forward-looking statements should be considered in light of these factors.

Please also note that as a Safe Harbor, any outlook as presented today is as of today, and management does not undertake any obligation to revise any forward-looking statements in the future. Joining me on the call today are Mr. Tyler Robson, Chief Executive Officer; Mr. Chris Buysen, Chief Financial Officer; and Mr. Jeff Fallows, President.

With that, I would now like to hand it over -- the call to Tyler. Tyler, please go ahead..

Thank you, Everett, and welcome to everyone who has joined us for our second-quarter 2019 financial results conference call for the third- and six-month periods ended May 31, 2019.

As you'll have noticed, we accelerated our quarterly filing date to be within 45 days of the quarter end to coincide with our up-listing to the TSX Venture exchange, which happened last week.

Despite it only being our second quarter of third-party extraction operations, our revenue for the second quarter of 2019 sharply increased to $8.8 million compared to nil in the same period of fiscal 2018, and a 296% increase over the $2.2 million in revenue in the first quarter of 2019.

This significant acceleration in revenues was driven by a ramp in extraction services provided to some of our industry partners, including Canopy Growth, Organigram, Tilray, and Sundial. 8,547,000 grams of dried cannabis and hemp biomass was processed by Valens in the second quarter of 2019, a 376% increase over the first quarter of 2019.

We have already processed 7,348,000 grams of biomass in the first 48 days of the third quarter. Revenues and processing volumes are expected to continue to increase in the coming quarters as we execute on our existing agreements; and, in some cases, such as with Tilray, scale and expand the scope of them.

We also continue to see more and more cultivation facilities including hemp come online in Canada, accelerating demand for extraction capabilities for our new customers who are preparing for legalization of edibles and concentrates later this year.

Our increase in production volume also enabled us to achieve economies of scale, strengthening gross margins to 58% of revenue in the second quarter, up from 38% of revenue in the first quarter 2019. Our ability to partner with established and high-profile licensed producers validates our position as a leading diversified extraction platform.

More importantly, our highly specialized expertise has given us a unique platform to springboard into white label product development to further integrate ourselves into the cannabis ecosystem. This is an exciting opportunity for us.

And we will ensure that the Valens business model is not only uniquely positioned to leverage the growth in the domestic and international cannabis market, but that it also builds a highly defensible platform over the long-term. Our product development activities are well underway.

We are providing formulations, tinctures -- formulations for tinctures, two-piece caps, as well as finalizing various formulations for vaporizer cartridges, gel caps, topicals, beverages, and other innovative products.

We plan to white label these for our industry partners in time for a product launch scheduled for December 2019 when oils and edibles hit the shelves across Canada.

We expect our revenues to continue to grow over the next several quarters as we execute on our existing extraction contracts, continue to grow our white label service with the new and existing customers, and expand our capabilities in product development.

To support this scale -- the scaling of our operations and accelerate our entry into new territories, we appointed Jeff Fallows as President of Valens, effective June 1.

Jeff was focused -- will be focused on executing on domestic and international growth opportunities, capital market strategy, and insisting with our overall corporate strategy in the Company. I will now turn the call over to Jeff to talk more in detail about some of our strategic development initiatives that he will be overseeing.

Jeff has a proven ability to build relationships with clients, and an extensive professional network understanding the cannabis sector. We are excited to have Jeff join the Valens executive team to help lead the Company through its next phase of domestic and international growth.

I will continue to lead the scale-up of our operations, global marketing campaigns, and lead business development initiatives. Jeff, please go ahead..

Thank you, Tyler. I'm excited to be a part of the Valens team, particularly at what I believe is a critical inflection point in the development of our Company and as we look to realize on the incredible domestic and international opportunities ahead of us.

I'm first going to highlight our second-quarter activities and then discuss our white label product development strategy, as this presents an immediate opportunity for Valens to diversify its revenue streams and build new partnerships.

During the second quarter, we signed multiyear agreements to provide cannabis and hemp extraction services to The Green Organic Dutchman, HEXO, Tantalus Labs, and expanded our agreement with Tilray.

Valens has commenced processing the cannabis and hemp biomass provided by some of these new partners already, and anticipates full integration of contracted volumes in our production cycle by the end of the third quarter 2019.

These agreements continue to validate how licensed producers of premium products are coming to Valens for our extensive expertise and leading methodologies to formulate unique experiences for their customers and broaden their product portfolio.

Our capabilities extend across a number of extraction methods and are designed to produce a higher quality, more consistent end product. This broad portfolio of services we tailor our services to each of our customers, enabling them to diversify their products and produce superior results across multiple product categories.

As you can imagine, this elevates Valens beyond the role of a service provider and establishes us as a core driver of our customers' business strategies. In the second quarter, we became the first third-party cannabis extraction company in Canada to receive organic certification for cannabis oil production from Pro-Cert Organic Systems Limited.

The certification is in accordance with the Canadian organic standards, giving us the ability to produce certified organic cannabis oil from hemp and cannabis biomass that is organically cultivated and certified.

Following receipt of this certification, we immediately started offering certified organic cannabis oil processing to The Green Organic Dutchman under the multiyear extraction agreement announced on March 11, 2019.

We expect the demand for organic cannabis and hemp products to grow over time, and are pleased to position ourselves as the go-to extraction and formulation provider for the organic market. We are prioritizing scale, a wide breadth of offering, and a premium service as a means of supporting high margins and a defensible, long-term business model.

To retain these differentiators and ensure we maintain our current position as a leading and the largest third-party extraction company in Canada, we are continuing to invest in our infrastructure. In the second quarter, we increased our annual extraction capacity to 425,000 kilograms of dried cannabis and hemp biomass.

Furthermore, we commenced construction on our recently acquired adjoining facility in Kelowna, British Columbia. This purpose-built facility will significantly increase the Company's footprint and is anticipated to be completed in the first half 2020.

Once completed, this expansion will more than double our current extraction capacity to over 1 million kilograms per annum and expand our contract manufacturing capabilities to deliver on demand from our existing [ph] partners.

In accordance with our strategy to contain customer concentration risk, no individual customer currently uses more than 20% of our capacity. This has meant that, in the past, we have had to turn down additional business when some of our larger customers approached that threshold.

Increasing our extraction capacity will allow us to ramp contracts with our existing partners as more biomass is produced by the market, and as well as take on new customers. As the cannabis market evolves, we expect to see the creation of entirely new categories of cannabis-based products driven by a greater understanding of the uses of cannabis.

Valens has the expertise and technology to support the production and sale of a wide array of tinctures, capsules, concentrates, vapes, topicals, beverages, and edibles. We are already working on these product formulations, including developing cannabis-infused beverages through our agreement with Tarukino.

Edibles and concentrates are expected to hit the shelves in Canada in December this year, and are a near-term growth catalyst for Valens. Our formulation portfolio will be essential to the development of new innovative products in these categories, enabling our partners to differentiate their offerings.

We expect this to drive significant growth and eventually surpass our extraction revenues as early as the second half of 2020. In summary, we believe we are well positioned to build on the momentum generated in the first half of 2019 and are focused on driving scale, profitability, and shareholder value in the near and long-term.

In the near term, cash flow from existing contracts will provide the financial flexibility needed to grow and maintain our competitive advantage.

In the medium and longer-term, expansion of both our operational footprint and our product portfolio will allow us to expand existing relationships as well as establish new ones that will expand our reach into new markets and geographic territories. I'm truly impressed with everything Tyler and the team at Valens have accomplished.

They built an exception business that is strategically well positioned and ready for significant growth. With that, I'll turn the call over to Everett Knight, Executive Vice President of Strategy and Investments, to talk about how our recent operational milestones and investments in our business are building shareholder value.

Everett?.

Thank you, Jeff. We have achieved a lot over the past six months, yet it is still early in our development, and we look forward to executing on our strategy and growing the value of the business. There is a major opportunity ahead of us, and we are confident we have a sound business strategy in place to rapidly accelerate our growth.

We were pleased to see our recent accomplishments are already starting to build shareholder value. As a result of our recent growth, Valens became eligible for the inclusion in the Horizons ETF earlier this month. This is the world's first ETF offering direct exposure to North American listed securities that are involved with cannabis production.

Being included in the ETF is an acknowledgment of the progress we have made executing on our mission, and the strong support we have received from the investment community. Inclusion in the ETF is expected to increase our exposure among investors, provide additional liquidity for our stock, and broaden our shareholder base.

We were also recently accepted for listing on the TSX Venture exchange, and commenced trading on Wednesday last week. Up-listing benefits our shareholders for several different reasons, including opening up more institutional and international investors that are now able to purchase Valens stock, which important for liquidity.

Looking ahead, we will continue to ensure that building value for our long-term shareholders drives our strategy and that we maintain open dialogue with our shareholders at all times.

Valens is increasingly being recognized as having a disruptive, unique, and incredibly positive impact on the cannabis market by investors, licensed producers, and other credible voices in the industry.

Last month we were invited to speak at Cannabis Europa, the largest cannabis conference in the United Kingdom, which had over 1,000 attendees; as well as the Piper Jaffray Investment Conference in New York City. We have been featured in Benzinga magazine and have been quoted in Bloomberg and Financial Post as well as other well-known outlets.

With this continued momentum, we remain focused on maximizing shareholder value by investing in projects that drive the highest long term return on invested capital for our investors. We have had a strong first half of the year. And I'll now turn the call over to Chris, who will talk through our financial results..

Thank you, Everett. Revenue for the second quarter of fiscal 2019 is comprised of revenue from proprietary and industry-leading extraction services, the sale of cannabis and hemp biomass, and analytical testing revenue from Valens Labs. Revenue increased to $8.8 million in the second quarter compared to $23,000 in the same period in fiscal 2018.

This increase in revenue is due to extraction service revenue of $8.74 million as the Company continues to scale its cannabis and hemp biomass received from industry partners for processing.

Throughout the quarter, we continued to experience an increase in size and frequency of shipments as we anticipate to continue through the remainder of the year as we bring additional equipment online to meet demand.

Additionally, that Company generated $0.19 million in revenue from analytical testing through the Company's ISO 17025 accredited lab, including $0.14 million in inter-company testing revenue.

Gross profit increased to approximately $5.1 million or 57.9% gross margin for the second quarter compared to $9,000 in the same period in fiscal 2018, and $0.85 million or 38.3% gross margin in the first quarter of 2019.

The quarter-over-quarter strengthening in gross profit percentage was anticipated, and was a direct result of the increased efficiency gained through the higher production volumes realized in the second quarter.

The increase in gross profit from extraction services for the three months ended May 31, 2019, was $5.1 million or a 58% gross profit compared to nil in the same period in fiscal 2018.

The analytical testing operations saw an increase in gross profit for the three months ended May 31, 2019, of $0.11 million or also a 58% gross profit compared to $19,000 or 38.4% gross margin in the same period in fiscal 2018.

Operating expenses for the second quarter were approximately $6.7 million compared to $2.5 million in the same period in 2018.

This increase is primarily attributable to higher advertising and promotion expenses, share-based payments, depreciation and amortization costs, salary and wage expense, as well as an increase in office and miscellaneous expense as the Company scaled its operation to meet anticipated demand for its services in 2019.

Loss and comprehensive loss for the second quarter was $10.5 million compared to $2.4 million for the same period in 2018.

This increase was attributed to a $3.2 million impairment of the Company's redundant Supra sales testing license previously classified as held for sale under the Roto-Gro share purchase agreement; and a one-time, non-cash contract termination cost of $5.9 million resulting in the acquisition of Straight Fire Consulting LLC that was previously disclosed on our Q1 earnings press release.

The acquisition was strictly a result of the consultants' tax planning strategy, thus reducing the number of shares the Company was required to issue to terminate the consulting agreement. On the date of acquisition, Straight Fire Consulting LLC did not have any assets or liabilities.

The Company is in the process of developing Straight Fire Consulting LLC. This agreement was entered into under our former Board at a very different stage in the Company's development. And as the Company grew and we prepared to list on the TSX Venture exchange, this agreement was no longer in the best interest of the Company or its shareholders.

This contract had no bearing on our ability to drive shareholder value and future shareholder return on invested capital. The Company had $65.5 million in cash and cash equivalents and short-term investments as of May 31, 2019, compared to $25.2 million as of November 30, 2018.

The decrease is due to the closing of the April 2019 bought deal financing for net proceeds of $38.6 million, and the exercise of warrants for gross proceeds of $22.6 million. These funds will primarily be used by the Company to continue to execute on its growth strategies as well as general corporate and working capital purposes.

With that, I will now turn the call over to the operator to open the lines for the Q&A..

[Operator Instructions]. Our first question here is from Neal Gilmer from Haywood Securities. Please go ahead..

Congratulations on the Q2 results. I wanted to maybe start off just on your outlook over the course of the second half of 2019. Obviously with your increased capacity to do the 425,000 kilograms, you are still operating at a fraction of your overall capacity.

How do you see that scaling up? And maybe in particular as you take a look at some of the hemp product that's being grown in Canada here, are you expecting a fairly significant increase in your utilization rate -- I think, really heading into Q4?.

Thanks, Neal. This is Everett here. We are expecting a gradual increase over the next few quarters as our customers ramp up on production in the Canadian marketplace and we have more greenhouses coming online.

With hemp being grown in the summer and harvested in October-November time frame for us for an extraction standpoint, we should see an increase in that capacity going into that 2020 time frame. But it's just going to be a gradual increase. I think as you saw in the quarter, we did just over 8.5 million grams of extraction in the quarter.

But even in the 45 days subsequent to quarter-end, we did 7.35 million almost grams of extraction already. So you can see that ramp-up taking place, albeit the big ramp up happening in Q1 2020..

Okay, that's fair. Thank you for that. Maybe just to follow on with that, we saw great improvement on your gross margins quarter over quarter.

Any color you can provide on how that scales up as you increase the capacity on the machines?.

Yes, I think it gradually expands. I don't know if we don't see much margin expansion going into Q3. But going into Q4, we expect this to continue as we get more economies of scale -- as a corporation, we get more actual cannabis and hemp in the facility itself..

Okay, thanks. You guys touched on it a little bit in your prepared remarks, but maybe just to try to poke you a little bit further on some of your white label product development.

I guess you are working with your partners; any sort of timelines you can provide as far as prototypes into them and so forth? And how we see this play out, such that you've got that product into the market in December of this year?.

Yes, I think people underestimate this category for us. And if you look at the formulation is taking place today and preparation, we're currently doing tincture and two-piece caps in-house today.

And if you look at going into edibles and concentrates coming online later this year, we were really concentrated on vape pens, cannabis-infused beverages, capsules, topicals, as a few other cool products coming online. I think the biggest concentration for us is vape pens. We think it is going to be one of the biggest categories in the marketplace.

And Neal, from your expectations, I think we have a very robust white label pipeline right now. And we actually expect those contracts to surpass the number of extraction contracts we have, and I think that will happen in the next six months..

That's great. Thanks. I'll leave it there and jump back in the queue if I have further questions..

Our next question here is from Greg McLeish from Mackie Research. Please go ahead..

I just wanted to dig down a bit on -- dimension -- you processed just over 8.5 million grams in the quarter. And on a revenue per gram basis it was just about $1.02, and that was down a little bit on a -- from Q1.

Can you break down what the split between hemp and cannabis was in the quarter?.

Yes. You guys, it ranges very quickly. And for each customer, it has a different mix. So overall from a modeling standpoint, I'd say 50-50 is good modeling scenario for cannabis versus hemp, because obviously those have different pricing.

And then going into the October-November time frame as we see these big harvests come online from hemp in Canada, I'd say that would shift substantially to the hemp market. And obviously that's an increase in overall product coming in. But I would say that big increase will be in that hemp marketplace..

Okay, so what we'll see in that October time frame is just revenue per gram probably goes down because you've got more hemp; but you're processing more because there's going to be a lot of hemp going through the facility..

Correct. That's our expectation..

Perfect.

And just looking at a bit of what Neal was talking about and also the comments that you made in the -- in your presentation, you expect your white label to exceed your cannabis extraction revenue by when?.

In our prepared remarks earlier on, we could see that as early as the second half of 2020, depending on how fast the Canadian marketplace ramps up.

But I think from a contract standpoint -- we have 10 extraction contracts today -- I think what you're going to see in the next six months is that we have more white label contracts than we do extraction contracts. And that will happen, obviously, as the marketplace comes on later this year..

And that will, I guess, change your margin profile dramatically because the white label should be higher-margin products..

Yes. I think that people take white label as every product. Every product is different. Today in the Canadian marketplace, still toll extraction is the highest revenue and margin today. So from a margin standpoint, it is the highest margin. Going into white label, it depends on what product.

But we do see a huge opportunity from a margin standpoint, especially in a few of those product categories..

But I guess longer-term, the white label is going to be far more sticky than the potential tolling revenue; because as other LPs or companies bring on extraction capability, there will be some price compression.

So the white label is probably the best route to go longer-term?.

I think that's fair to say. This is Jeff talking now. In the short term as we are ramping up the facility, the toll contracts made a lot of sense for us and provided the margin. But certainly over time as the market evolves, the margin profile will shift towards white label, for sure..

Great. And then just one more question. You did say you processed just over 7 million grams in the first 45 days.

How is this ramping up in the next 45 days? Was it a slower ramp-up, and now you are seeing a more aggressive ramp? And is that going to happen through the balance of it into August?.

Yes, you should absolutely see month-over-month increases in volumes coming through facility..

Great. I'll get back in the queue. Thanks, guys..

Our next question here is from Ryan Macdonell from GMP Securities. Please go ahead..

Congrats again on the strong results. So just maybe one housekeeping one, just to start off with. In Q1, I believe purchases of raw flower were a material impact on gross margin.

I'm just wondering, was that again the case in Q2?.

We did have a mix of actually buying and helping customers out with buying cannabis and selling it back to them. But I would say it's more of an economies of scale, Ryan, as we ramp up our operations.

So if you look, as we get greater capacity in-house and more kilograms, as you are seeing even in Q3 in the first 45 days, that economies of scale should expand, helping our overall margin profile gradually.

And just as I said to Neal, beginning, I think, for Q3 I don't think we're going to have large expansion, but in Q4, as we see more product come in the facility, I think you really see the leveragability of that economies of scale..

Okay, cool. That's helpful. And then maybe just one on international. Hasn't really been talked too much about so far in the call today, but I know you previously spoke about it. I'm just wondering, maybe could you frame for us maybe what markets we could see you move into first.

I know previously you talked about the US hemp and potentially Europe as well, but any color you can provide there would be very helpful. Thanks..

Hi, this is Jeff. So we're looking at a number of international markets. The strategy for us right now is determining where it's best to deploy the capital and what provides the best opportunity for us.

So I'd say there's a number of opportunities currently that we're reviewing, and that will be -- able to provide greater clarity on what those markets, or what markets we're focused on, in the coming months..

Okay, thanks. That's all for me..

Our next question here is from David Kideckel from AltaCorp Capital. Please go ahead..

Congratulations on your impressive quarter. Some of my questions have already been addressed. I did want to focus a little bit on Tarukino and beverages.

Should we be thinking, as we are modeling white label and tolling now, and also maybe forward, just for line items, should beverages be included within a white label type of business model and associated margins with that as well?.

Yes, it's definitely a core part of our product portfolio, going into edibles and concentrates later this year. I think people underestimate the beverage market and the capabilities, especially with a technology like our SoRSE Technology in-house. That emulsion technology I think is really important for the future of cannabis beverages in general.

Right now, you have problems with oil actually not having water solubility. And what it does is it creates it completely water compatible. And the big differentiator is it is consistent with every sip. So the first sip is the same as last sip, which is important from dosing going into this marketplace.

As well as onset and offset, David, as we've chatted about before, is going to be particularly important with competing with alcoholic beverages. So right now, it takes 30 minutes to 2 hours for you to actually to feel the effects of a cannabis-infused beverage, and it lasts for 4 to 8 hours.

Where if you have an emulsion technology, we have observed it to be in 5 to 50 minutes with SoRSE. And it actually offsets -- or you kind of come down from the high in about 45 minutes to 2 hours, which is a game changer. So it definitely is a line item, and we're really excited about it going in later this year..

Okay. Thanks, Everett. Going back, as well, to the international growth strategy, when we're -- and given that you mentioned in your prepared remarks, as well, we know you are on the US-based ETF. One of the criteria for that is to make sure obviously that companies are selling and producing in a lawful way, which obviously Valens is doing.

So if we're interpreting a potential entry into the US, should we be thinking about this purely from hemp-based CBD? And if so, does that also include Tarukino? So in other words, with Tarukino, are you able to manufacture Tarukino-based product with hemp-based CBD? Or does this also include THC, which would potentially limit the opportunity in the US for this other product?.

Hi, David. It's Jeff. I think that you can look at the US opportunity as one that we're continuing to monitor. We certainly -- as you're saying, we certainly won't be doing anything that goes against our listing on the TSX or otherwise.

We're looking for the right opportunity and the right ways to enter, much like we are in the other markets internationally. I think you can look at it as -- we're looking for the -- where's the best -- which is the best way to enter each market, whether that's a brownfield, greenfield, or acquisition.

And we're also looking at which is the best market to provide the best return on capital for us. But, certainly, we won't enter any market that violates our listing requirements..

Understood. Okay. And then just for just timing, from a timing perspective with international markets, whether it's -- whichever markets you are planning on entering first, is there any sort of guidance you can give? Just with a general sense of timing, is it the first half of 2020? Or just something to wrap our heads around..

I think you should -- I think it's -- you can expect that we will be making announcements on the different market opportunities we'll be pursuing in the next couple months, David. But, certainly, we should be able to have a finalized announcement before 2020..

Okay, great. Thank you..

This concludes the question-and-answer session. I would like to turn the floor back over to Mr. Robson for any closing comments..

Thank you to everyone who asked questions. We are pleased with the significant revenue growth and improvement in gross margins reported in the second quarter. These results are expected to continue to strengthen as the global cannabis market continues to climb.

We are currently the industry's most trusted partner provider of comprehensive offering of CO2, ethanol, hydrocarbon, solvent-less, and terpene extraction methodology with a solid strategy in place to expand our capabilities and product development and manufacturing.

This unique value proposition is supported by our new capacity and strong management team. Our recent progress has enabled us to attract high-profile cannabis experts to the Company, including the appointment of Deepak Anand to our Board of Directors as an independent member.

Deepak is recognized as a thought leader in the global cannabis space and has worked with many licensed producers, doctors, patients, policymakers, senior government officials in the cannabis industry.

Our progress is driving a sharp improvement in our operating results, resulting in reported adjusted EBITDA of $2 million in the second quarter, or 22% of revenue. This impressive adjusted EBITDA margin compared to competitors shows attractiveness and focus on long-term extraction contracts.

Thank you again to all the long-term shareholders for their support. I'll now turn the call back to the operator to close the lines..

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation..