Welcome to the Valens Company Fourth Quarter and Fiscal Year 2019 Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Everett Knight, Executive Vice President of Corporate Development and Capital Markets of the Valens Company. Please go ahead..

Thank you, operator. Good morning, and welcome to the Valens Company fourth quarter and fiscal year 2019 financial results conference call. A replay of this call will be archived on the Investor Relations section of the Valens website at www.valenscompany.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, 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 over the call to Tyler. Tyler, please go ahead..

Thank you, Everett, and welcome to everyone who has joined us for our fourth quarter and year-end November 30, 2019 conference call. When I compare where we are now to where we were at the start of fiscal 2019, the difference is vast.

At the beginning of the year, we were primarily an R&D company, building out a diversified extraction platform and a number of testing methodologies with no meaningful revenue.

12 months later, in the fourth quarter of 2019, we have become the most profitable publicly traded company – cannabis company in North America, excluding fair value adjustments and onetime item.

We were able to achieve this nominal growth by securing and executing on multiyear extraction contracts with leading players in the cannabis sector, which positioned us as the partner of choice to the industry.

In the second half of 2019, in preparation for Cannabis 2.0, we broadened our platform beyond extraction to include white label product development and manufacturing.

We now produce a broad portfolio of safe, consistent, innovative products to both license producers and unlicensed companies, such as brand focused entities and consumer packaged good companies to help differentiate themselves and build their brands in the cannabis market.

High-purity distillates and Cannabis 2.0 destined oil-based products contributed to the record revenue in the fourth quarter of 2019. We leveraged cross-selling opportunities with key extraction customers to launch new products and broaden their product portfolio.

We are also rapidly securing and increasing a number of white label contracts with new customers, which Jeff will elaborate on later in today’s call.

We are currently the most diversified largest extraction and product development and manufacturing company in Canada, and with the capacity to manufacture more than 25,000 kilos of distillate and a broad portfolio of next generation oil-based product.

To ensure we have the capacity and flexibility to handle continued acceleration in demand for our products as well as handle seasonal variations in demand, we are expanding our 425,000 kilogram extraction input to over 1 million kilograms and adding significant scale to a number of our manufacturing capabilities in the second half of 2020 once our expansion in Kelowna comes online.

We believe our multi-year contracts, manufacturing platform, proprietary technologies and advanced product capabilities uniquely position Valens in the cannabis market and provide sustainable competitive advantage through which we will continue to service our customers and generate shareholder value.

In the fourth quarter, we generated record revenue of $30.6 million. This represents an 86% increase over the third quarter and a 248% increase over the second quarter of 2019. This increase was due to scaling our extraction activities as well as meaningful Cannabis 2.0 destined product sales.

Gross profit for the quarter increased to $22.6 million or 73.8% revenue compared to $12.8 million or 77.8% of revenue for the third quarter of 2019. Adjusted EBITDA was $17.7 million or 57.7% of revenue compared to adjusted EBITDA of $9.8 million or 59.4% of revenue in the third quarter.

While we continue to expect strong margin throughout 2020, we do expect some margins to moderate over the coming quarters as white label product initiative make up an increasing percentage of our revenue.

As discussed in our Q3 conference call, while these products generate more conservative margins, they represent a key strategic shift in our business, allowing us to be a one-stop shop for customers and further integrate ourselves into their value chain. Finally, net income.

The quarter was – net income in the quarter was $4.5 million, a 14.6% net income margin, making us the most profitable publicly traded cannabis company in North America with the highest net income margin, excluding fair value adjustments and onetime items.

I’ll now turn the call over to Jeff Fallows, President of Valens, to dive deeper into our operational achievements in Q4. I’ll be available to answer questions at the end of this call..

Thanks, Tyler. I’ll first look at our recent achievements from the quarter, including some of the work we’ve been doing with our industry partners. We expect several significant developments in 2020 as Cannabis 2.0 rolls out and the global markets open up. So I’ll also discuss these plans in our long-term vision in more detail later in my comments.

We processed 61,394 kilograms of dry cannabis and hemp biomass in fiscal 2019, of which 24,426 kilograms of dry cannabis and hemp biomass was processed in the fourth quarter.

As expected and discussed on the Q3 conference call, our processing volumes flattened in the fourth quarter as our production mix shifted to a number of smaller lot runs in order to help our customers launch a broad assortment of products into the Cannabis 2.0 market.

While this decision resulted in reduced volumes, it allowed us to expand our agreements with a number of customers to process white label products and increase our revenue per gram of input to $0.25 per gram in the fourth quarter of 2019 compared to $0.61 per gram in the third quarter.

Revenue per gram is expected to increase further in 2020 as product development contracts continue to grow in number and contribute to a higher proportion of total revenue. The number of white label product development contracts we have signed continues to ramp significantly and now outnumber extraction only contracts.

This puts overwhelming demand for white label product development and manufacturing services. In December, we entered into a multiyear manufacturing agreement with a Health Canada license party that provides us with additional license capacity.

An initial 5,000 square feet has been allocated to Valens operation with a total of up to 50,000 square feet being made available, subject to the counterparty receiving the required Health Canada license amendment.

On our last quarterly call, we discussed some of our agreements we signed in Q4, including major contracts with Iconic Brewing and Shoppers Drug Mart. Since then, we have continued to secure new customers, including our largest publicly announced multiyear white label agreements to date for our branded finished products with BRNT Ltd.

BRNT is a leading premium cannabis ancillary company, which has shown impressive sales growth. They approached us to launch a line of unique, high-quality cannabis vape pens in Canada with a minimum of 2.2 million vape pens to be produced over initial two-year term.

We believe this represents gross revenue potential to Valens of over $50 million in the first two years, subject to final acceptance from the provincial distributors, including acceptance of the proposed price per unit.

We expect to complete our first shipment for BRNT in the first half of 2020 and are delighted to be collaborating with them to bring to market a line of differentiated vape products for Canadian consumers.

Subsequent to the year-end, we secured a number of new contracts, including a multiyear distillate and SoRSE emulsion supply agreement with Dynaleo, which is a large-scale edibles producer. The team at Dynaleo have been active in the Canadian cannabis sector for many years, advocating for safe, high-quality edibles for the adult use market.

They are rapidly scaling their operations with a purpose-built state-of-the-art large-scale facility coming online in 2020, which will give Dynaleo the capacity to produce more than 400 million units in the first year of operations. We are delighted to be partnering with them at this exciting point in our growth.

In December, we also announced a multiyear extraction and white label agreement with Emerald Health Therapeutics, Inc. We have already started formulating, mixing and filling products for Emerald Health in preparation for vaporizers, softgels and tinctures.

As our customers continue to roll out products in Canada for Cannabis 2.0 and the size of the market expands, we expect to secure more sales opportunities that are even larger in size and encompass a broader array of the products.

We are excited about the opportunities, not just in Canada, where we expect demand for our services to continue to accelerate, but also globally, as international markets open up. We are confident we can leverage our expertise to be a pioneer in the global cannabis market as it moves into legalization.

In February 2020, we achieved a milestone when we announced our first international purchase order for the shipment of white label products to customers in Australia. We expect to ship three SKUs of tinctures totaling 3,000 units starting in Q2 2020 pending receipt of necessary importing network permit.

We believe Australia’s strong underlying demand for cannabis products, together with the continued adoption of medical cannabis laws and potential relaxation of CBD laws, will drive sustained growth in the Australian market. We continue to expand our footprint in Australia as well as other key international markets as they open up.

To further prepare for this, we expanded our exclusive license for SoRSE cannabis emulsion technology to include Europe, Australia and Mexico in addition to Canada, representing a nearly 20 times increase in the addressable population.

This access to international markets in the near-term is the unique differentiator for Valens and bolsters our white label product offering. The consideration for the exclusivity and the expanded geography was US$10 million, consisting of $6 million in cash and $4 million in common shares.

The agreement carries an initial five-year exclusive term with a two-year renewal of the exclusivity subject to certain performance milestones related to operational and financial achievements. As part of the agreement, Valens will transfer to SoRSE royalty payments, which are subject to an annual minimum of $2 million over the term.

While we are committed to global expansion, capital expenditures will be mainly focused in Canada with a view to exporting products to medical markets that have limited distribution.

We aim to responsibly manage our growth to build a sustainable business over the long-term, so we can truly maximize the opportunity inherent in the global cannabis market. As these international markets mature, we are on the lookout for acquisition and other opportunities that provide us with an accelerated platform to gain market share.

I look forward to providing further updates on our international strategy as 2020 progresses. With that, I’ll now turn the call back to Everett Knight to talk about some of our corporate and capital markets development. Everett, please go ahead..

Thank you, Jeff. As Jeff and Tyler mentioned, we’ve come a long way in a relatively short space of time.

As we enter the next phase of our growth driven by our extensive white label product development and manufacturing capabilities, together with the rising demand for 2.0 products, we are cognizant of the need to keep our shareholders at the heart of all of our decision-making.

This approach will ensure we always have the strongest foundation to navigate our growth with the emerging cannabis market. In December, the TSX Venture Exchange approved the normal course issuer bid, otherwise known as an NCIB, to acquire up to 6,275,204 Valens shares over the next 12 months, which, if utilized, will be funded with cash on hand.

Given our strong financial and operational performance, prevailing market conditions and the value of our shares, we are pleased to have the NCIB in place at this time.

We’re also pleased that our operational accomplishments continue to be recognized by the investment community, and we have been included in the recently introduced S&P/TSX Cannabis Index, XCAN, which is comprised of a select group of cannabis issuers trading on the TSX and TSX Venture Exchanges.

Our shares are also now DTC eligible in the U.S., which should provide increased visibility and accessibility for our shareholders moving into fiscal 2020 and allow us to reach new investors in larger markets. We expect to continue to analyze different exchange opportunities in the near-term to access more liquidity for our shareholders.

We are still seeing a significant supply of flower on the market, and the launch of Cannabis 2.0 products in Canada has been met with strong initial customer demand. These fundamental market dynamics are expected to drive demand for our services throughout 2020 and beyond.

We believe the product offering with consistent high-quality and predictable user experience will capture the most market share and empower brand development in a strict regulatory environment.

We are proud to have been entrusted by several leading brands to produce white label products, and we are currently formulating and manufacturing 19 SKUs over three different 2.0 product line.

To meet demand for our customers in 2020, we’ll continue to invest in developing the intellectual property that will define tomorrow’s cannabis market across a range of products, including vape pens, edibles, concentrates, cannabis-infused beverages, topicals, tinctures and capsules.

Our focus on innovation and ability to provide a broad range of services throughout the supply chain, including customized formulation, emulsion and terpene enhancements, uniquely positions us to service a wide range of customers.

We believe this innovation and focus on consistency, led us to have what we consider to be the highest quality APIs of distillate, isolate and other custom formulations in the market.

This diversification strategy in our white label business is also enabling us to build a broad IP portfolio for product development that spans all products from tinctures and beverages edibles to topicals and concentrates.

During the fourth quarter, to accelerate our commercial scale entry into the high-growth beverages and edibles market, we acquired Pommies Cider Co. for $7.6 million. Pommies is a leading Ontario-based beverage company and mature cannabis microprocessing license applicant.

Initially, we intend to leverage the beverage manufacturing infrastructure of the Pommies facility and the know-how of its founders to capitalize on cannabis-infused beverage white labeling opportunities including our existing agreement with the Cannabis division of Iconic Brewing and other potential partners.

We are already producing beverages in Western Canada that should be on the shelves in the next few months, but look to increase current capacity once the Pommies facility is online.

To ensure we retain our leadership position in this market as it matures, we are budgeting for approximately $10 million of capital expenditures over the next – at the facility over the next 12 months, following which, Valens expects to have a significant capacity for beverages, edibles and SoRSE emulsion formulation in Greater Toronto area.

The planned capital expenditures to bring the facility into full operation are fully funded with cash on hand. With that, I will now turn the call over to Chris Buysen, CFO, to talk about our financial results..

Thank you, Everett. Based on the operational achievements highlighted earlier in this call, consolidated revenue increased to $58.1 million for the fiscal year ended November 30, 2019.

This annual revenue growth was driven by strong fourth quarter revenue of $30.3 million, an 86% increase over the third quarter and a 248% increase over the second quarter of 2019.

Revenue for fiscal 2019 is comprised mainly of revenue from proprietary and industry-leading extraction and white label manufacturing services, the sale of cannabis and hemp biomass and oil and oil-based products destined for Cannabis 2.0 products.

During the year, we experienced an increase in order volume and frequency of shipments, which we anticipate continuing through 2020 as additional equipment is coming online, including expanding our hydrocarbon extraction, to meet this demand.

Revenue from the cannabis operating segment increased to $30.5 million in the fourth quarter of 2019, up 86.6% from $16.4 million in the third quarter of 2019.

Additionally, in the fourth quarter of 2019, company generated $0.36 million in revenue from analytical testing through the company’s ISO 17025 accredited lab, including $0.27 million in intercompany testing revenue. With our rapid top line revenue growth in the fourth quarter, customer trade receivables increased to $34.4 million.

Since year-end, we are pleased to have already collected or have trade payables with the same partners on 81% of these receivables, which bolsters our already strong cash position and speaks to the strength of our current relationships, contracts and the underlying cannabis market.

Consolidated gross profit increased to $41.4 million or 71.2% of revenue for fiscal 2019. For the fourth quarter of 2019, consolidated gross profit increased to $22.6 million or 73.8% of revenue compared to $12.8 million or 77.8% of revenue for the third quarter of 2019.

As mentioned on our Q3 earnings call, the strengthening in gross profit percentage for the second half of fiscal 2019 was aided in part by onetime contract opportunity in addition to our ability to realize increased efficiencies through the higher production volumes achieved through the year.

The gross profit from the cannabis operating segment in the fourth quarter was $22.6 million or 74% compared to $12.7 million or 77.3% in the third quarter of 2019.

Analytical testing operations saw a slight decrease in gross profit in the fourth quarter of fiscal 2019 to $137,000 or 38.5% of revenue compared to $146,000 or 67.3% of revenue in the third quarter, driven by higher intercompany service utilization.

Operating expenses for the year were approximately $33.1 million compared to $13.8 million in the same period in 2018.

The increase from the same period in 2018 is primarily attributable to higher [Audio Dip] depreciation and amortization costs, salaries and wages and advertising and promotion expenses, as the company scaled its operations to meet demand for services in 2019. Adjusted EBITDA was $27.4 million for fiscal 2019.

For the fourth quarter of 2019, adjusted EBITDA was $17.7 million or 57.7% of revenue, compared to adjusted EBITDA of $9.8 million or 59.4% of revenue in the third quarter. The company recorded a tax provision in the fourth quarter of 2019 of $6.3 million.

With the ramp-up of profitability through fiscal 2019, one of the company’s entities became taxable in the fourth quarter after using up all available noncapital loss carry forward. The company has strategies in place to effectively manage the overall tax structure of the company and review this tax structure on an ongoing basis.

The company posted a net loss in the year of $6.5 million, compared with a net loss of $15.9 million in the same period in 2018. For the fourth quarter, the company reported net income of $4.5 million. The company had – sorry, $58.7 million in cash and short-term investments as of November 30, 2019, compared with $25.2 million as of November 30, 2018.

The increase is due to the closing of the April 2019 bought deal financing for net proceeds of $40.3 million, 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 domestic and international growth strategy 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..

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] And our first question is from David Kideckel from AltaCorp Capital. Please proceed with your question..

Hi, good morning. Congrats on the quarter, guys. Thanks for taking my question here. A few questions I wanted to get through. First is, you mentioned the vapes hitting the shelves with BRNT, I believe, in H1 2020. Can you maybe comment a little bit on some of your other derivative or legalization 2.0 products in beverages, in particular.

When do you expect those to hit the shelves in Canada?.

Yes, sure, David. Thanks. Yes. So obviously, a number of vape pens SKUs available, tinctures SKUs and beverages. We’ve just received recently a PO from the Province of Ontario for beverages. So we expect to see those Iconic beverages on the shelves within the next couple of weeks..

Okay.

And the SoRSE beverages?.

Yes. So the Iconic beverages are SoRSE-based beverages..

Got it. Okay. Thank you. Moving on to vapes, and we’ve – I think everybody in this industry is well familiar and caught up with some of the controversies around vapes over the last several months.

I’m just wondering, now in Canada, in particular, especially with Alberta opening up and getting rid of that ban, how does Valens – how has your business been impacted with the controversy with the vapes, and now it’s a lot of it seemingly going away..

This is Jeff again, David. In the short-term, we didn’t really experience any major challenges with negative news in the vapes. It’s always been our position from a Canadian context that the labeling and the content requirements would allow us to provide safe and consistent products to the Canadian consumer.

So in the short-term, we didn’t notice any material changes. What it may have done was caused some of the longer term growth. But in the back of Alberta, a changing course and there being a number of SKUs in the market that are continuing to sell well. We view now that longer term opportunity is quite strong as well..

And David, just on that note – it’s Everett here. Look, I think we continue to see growth in that marketplace. And the initial demand has been good from customers as well as their consumers overall. And from our standpoint, like with our terpene formulations, we really differentiate ourselves from that.

And as we get more formulations and custom formulations for our customers with our unique capabilities there, I think we have a very unique opportunity..

Okay, thanks guys. My last question here, and then I’ll hop back into the queue. Just looking at CapEx here, and what was in your prospectus for 2019, which was a little light with what was the actual versus guided.

Can you maybe just give us some guidance for CapEx for 2020?.

Yes. David, it’s Everett here. So you can see it in the MD&A. We kind of made sure that we put it in there. So the CapEx is really for our K2 facility in Kelowna. So we have our current facility, K1, but in kind of the first half of 2020 here, it’s going to be fully built and then ramping up into the back half of 2020.

So we still have spending there, call it, $15 million to $20 million left. And then we’re also spending $10 million on the Pommies facility to build that out to get ready for edibles and beverages..

And that will also be in H1 2020?.

No. Pommies will be end of 2020, beginning of 2021, just depending on – if we both licensed edibles and beverages at once, we could do. We’re still deciding whether we get one up sooner or doing both at once. So that’s still evaluating that opportunity, and we’ll keep the market up-to-date with that progress as it develops..

But the CapEx will be spent over the course of the year, David..

Okay, thanks guys. I’m going to jump back into the queue. Again, congrats on the quarter..

Thank you..

And our next question is from Jenny Wang with Eight Capital. Please proceed with your question..

Good morning. Congratulations on the quarter guys. Thank you for taking my questions..

Thank you..

So the first one is just, could you talk about your receivables balance? And kind of are you finding companies paying back receivables on time? And how do you go about selecting the partners that you work with and ensuring that they have the capacity to pay?.

Chris, do you want to touch on this one?.

For sure. Yes. So we definitely are kind of actively managing our relationships with all of our partners. To-date, we haven’t had any issues with collectability. I think as we noted in our MD&A, we had, as of the end of the year, about $7 million over 60 days.

As at this point in time, there’s about $300,000 of that, that still remains outstanding or hasn’t been offset against payables with same vendor. And we’re confident that those amounts all remain collectible.

I guess, from a process standpoint, to answer the other half of your question, we definitely – as we’re kind of engaging in the different relationships we have with our partners, we do a lot of due diligence on the front end, making sure that we’re comfortable with who we’re investing credit to through those relationships..

And Jenny, just to further that comment, like, as far as our customers today, we have a very diverse customer group. And going into 2020, we forecast every customer being under 20% of our revenue. And if you look at that, most of them will be under 10%.

And I think you see that customer going to continue to expand, decreasing the impact of one customer in Brazil, like any one customer..

Got it. Thank you. And just in terms of – if you could just elaborate a little bit more on kind of the white label contracts and that’s currently in your pipeline.

At what point do you think we can begin to see sales from these contracts kind of outpace your total revenue?.

I think you’re going to start to see those white label contracts or branded player contracts with products in the shelves very soon – in the coming weeks here.

And as we move into the back half of the year, into Q4, we expected that those – the revenues and the – coming from those contracts, we expect to outpace and outnumber the extraction only contracts..

And just in terms of kind of the gross profit this quarter, 74%, that’s very healthy if I compare it to the second quarter, considering that in Q3, there was kind of a onetime opportunity that boosted margins.

Is it right to kind of think about gross margins, pretty healthy gross margins this quarter as a result of your white label manufacturing? And therefore, if white label were to continue, then should we kind of be expecting similarly healthy growth margin levels going into 2020?.

No, I think as we look at the gross margin profile, as we’re moving into more and more white label, I’d say it’s probably the opposite.

As we said in some of the commentary is that the margin profile that we’re going to experience, we believe will moderate over the next couple of quarters here than the overall EBITDA profile from white label contracts. We get more aggregate value per gram of input, but the margin profile is smaller.

So, I think you’re going to see that our margins moderate over the coming quarters here..

And just on that, Jenny, though, we’re not talking about a lot of moderation from our end. It’s just slight moderation as it becomes more of a mix, as you said, ramping up into Q4..

Thank you. I’ll jump back in queue. Thank you..

And our next question is from John Chu from Desjardins Capital Markets. Please proceed with your question..

Hi, good morning, everyone. First question would just be on the revenue per gram. You’re saying you’re expecting that to increase from the current level. So does that mean that you’re going to see less hemp in the near term? Because obviously, the revenue per gram would probably be a lot less.

Maybe talk about how that fits from a hemp perspective in white label?.

Yes. More of what you should look at, John, in that regard is more finished products being sold. For every finished product we sell, the revenue per gram is a lot higher. So your comment is correct on base extraction that on a per gram of input basis, our hemp extraction numbers are lower.

But if that same extracted oil goes into a finished product, that revenue per gram increases..

Okay. And then secondly, then, just on the – when I look at your deposits, you have raw material inventory of $7 million.

So can I assume that, that may be – you’re stockpiling some pretty cheap biomass from the quarter that you haven’t received yet? And presumably, that can actually help provide a bit of a boost for the upcoming quarter?.

Yes. So I don’t think I’d use the word stockpile. And Chris Buysen, please jump in as you want here. More I would say is that we get opportunities from time to time to get some strongly priced or well-priced products. We don’t speculate. We don’t take positions.

But if we have white label contracts that we have to fulfill later on in the year, we will be opportunistic and access those buys when they’re available..

Okay. Perfect. And maybe just talk about just prices in general, what you’re seeing out there. We’ve been seeing flower prices coming off. We’ve heard about extraction rates coming down, and there’s been a dispute, obviously, in the industry.

So where are you seeing things? Are some of the white label prices starting to come down from – versus where you were negotiating, maybe what you got six months ago? I’m just trying to get a sense.

Directionally, where some of these things are going?.

Hey, John, it’s Everett here. No, we’ve actually even seen the opposite of white label pricing increasing. You’ve got to remember, this is the beginning innings. Currently, you’re negotiating with the distributors, but once that prices that we have good visibility on that front.

The good news from a margin standpoint is that as dry cannabis prices continue to go down, we can increase our overall margin because we have the visibility on the end market, and that just goes straight to the bottom line..

You’re seeing a double whammy that when you’re seeing the white label prices increases, and then you can also see a benefit from the dry cannabis flower decreasing.

Is that right?.

Yes. I think as the market matures, you start – you’re going to start to see a different quality of products commanding different levels of pricing. So we’re starting to see some of that maturity come into the market in terms of higher quality areas getting higher pricing.

But absolutely, once the pricing is set in the provincial distribution areas, if the input pricing goes down, then that increases margin..

Okay. Thank you. I’ll get back in queue..

And our next question is from Kimberly Hedlin from Canaccord Genuity. Please proceed with your question..

Thank guys on great quarter.

So just with the Q4 results, can you provide any color on the volume mix in the quarter along with the pricing? Whether you saw certain areas strengthen or come down versus what you’ve guided to last quarter?.

So from a volume standpoint, we saw more cannabis going into kind of the 2.0 products. Obviously, everyone is getting ready to put vape pens and edibles to the marketplace, which means that they have to prepare and get, obviously, oil-based products and oil, in general, to the market. So our mix was really driven towards that white label.

And as we mentioned previously in the call, Kim, I think you see that continue to expand rapidly, especially with some of these new products coming here on the shelf shortly..

So you’re not willing to maybe give some specific volumes on that?.

We’re not disclosing specific volumes right now. But as we get more transparency on the mix of our white label, we’ll be giving more and more information to shareholders, obviously. It’s just we don’t have that mix, and we have so many SKUs going and it’s expanding every day. We just want to have visibility before we give that..

Got it. Okay. Well, maybe more just a general question on the 2.0 rollout and what you’re seeing on your end? Any differences across the provinces, certain products? Yes, just your thoughts on how the rollout is going in general..

So great initial demand on the rollout. I think that you’ve seen it in the news and from all investors where we’ve seen sold out products, and I think it’s continued to develop. Everyone’s got to remember that 50% or almost 50% in the market in the U.S. is oil-based products, and we haven’t had those in Canada yet.

So it’s really like half of the market coming online, and you’re seeing that from the initial demand numbers..

And in terms of supply?.

From a dry cannabis standpoint?.

No. On the 2.0..

Yes. I think what you’re seeing is there’s only really just over 10 sophisticated license producers with products on the shelf. And obviously, what people are having trouble with is keeping up to the demand today. It depends on what’s new, but I think you see that continue to be a trend, Kim, going forward..

Okay. Great. Thanks for taking my question guys..

[Operator Instructions] And our next question from Greg Mcleish from MRCC. Please proceed with your question..

Hi, guys. Just a couple of questions.

I was just wondering how white label revenue is going to sort of trend in this first half and then the second half of the year, sort of the revenue split or what you think it could be?.

Yes. So, I think you can see as the quarters evolve here that the white label percentage of revenue increases to the point when we get into the back half of the year that we believe the white label revenue will overtake sort of basic extraction revenues.

So in terms of mix, overall mix for the year, hard to say at this point exactly how quickly that white label accelerates other than that general trend. But likely, the majority of the 50% of our revenue for the year will likely still come from base extraction..

Great.

And then looking into 2021, I know it’s a little bit off, but do you think it could be 50-50?.

I think, it going into 2021, it could be actually more skewed towards white label..

Great. And just to – what we’ve seen in the industry is there are a lot of companies or a lot of LPs there that do have capital, sort of they’re constrained on a capital side, and a lot of them have sort of indicated that they have wanted to move into extraction or do some self extraction.

Are you finding that now what we’re seeing is companies not necessarily wanting to invest in basic extraction so that, that means potentially more business for you?.

Hey Greg, it’s Tyler. Yes, that’s exactly what we’re seeing. So as everyone knows, cash is king. With a lot of these LPs a little bit strapped of cash and getting a little bit tighter, we’ll definitely see the demand growing, and we’ll see some new contracts coming forward in the foreseeable future.

But yes, we have absolutely no issues filling our pipeline and the demand is getting significant. One of the biggest things, too, is our hydrocarbon. We’re one of the only ones to offer any third-party hydrocarbon products, so that’s going to be very highly sought after, which we’ll see in the foreseeable future as well..

Great.

And how big a lead do you think you have on hydrocarbon over the next nearest sky? Like, if I wanted to try to get license for hydrocarbon, how long it’s going to take?.

So it took us two years to get up and running, Greg, and obviously, you need reinforced concrete, unique fire suppression systems, HVAC systems, municipality approvals and walk through Health Canada regulations. It takes a long time. Took us two years to get there. I think we’ve laid the groundwork for anyone else getting it.

So is it that long for another person? No, I don’t think so. I think it’s faster. But a lot of our customers, the feedback we’re getting from them is saying, hey, we’re in a residential neighborhood, and we can’t even get zones for this. And we actually don’t want to put a bombproof room in our $100 million facility.

So I think we have a longer growth there than people think..

Great. And just one final question, what is sort of your pipeline for bringing on additional white label customers? It sort of leads into the first question I had is just that people are capital constrained, they don’t want to build their own facilities. You guys have capital, you’re building out capacity.

So, what’s the ability for you guys to continue to add large-scale white label guys?.

I think the opportunity is endless. And Greg, what you’ll see in the foreseeable future is us actually diversifying our customer base and moving away from some of our licensed producer partners and more going after the CPG relationships, where people are still dabbling their toes in the water, essentially with what they’re thinking.

So, it’s a unique value-add that they can come to us and basically test the waters, get the data, launch a few SKUs under a different brand. And then really make the correct decisions and how they proceed. So, you’ll see more CPG relationships coming out of Valens shortly..

And Greg, just further that point in previous points, obviously, with white label products, we’re seeing a slight margin compression because it’s coming online. But with these new contracts coming on, we’re seeing revenue, EBITDA growth and net income growth over the next few quarters and years, and we have a strong pipeline.

And I think that customer base is going to really drive that home, and you’re going to see it expand here..

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

Thanks, Greg..

Our next question is from John Chu from Desjardins Capital Markets. Please proceed with your question..

Hi, just a couple of questions here. So, just trying to understand the balance of the white labels coming online, which technically is a lower-margin business for you, but you’re really only operating at around 25% capacity utilization or 25,000 kilograms process, but you’ve got an annualized run rate of 425.

So, how does that – how do you reaching a higher utilization rate going forward? And start to help streamline the business economies of scale and whatnot, and help drive the margins versus some of the offset from the white label? Just how do we look at that going forward?.

Well, the two of them were not necessarily apart, John. So it’s all about downtime, right? So if we’re doing a lot of small lot runs, our actual capacity, if we were to operate that for a long period of time, wouldn’t be 425,000 kilograms, right? That’s an average number based on average processing size and downtimes.

So, the smaller the lots, the more the downtime, the less capacity we actually have. So, as you are continuing to get large volume runs from base extraction, that efficiency goes up. But also, as we get larger product runs for our white label products.

So instead of getting runs of 100,000 vape pens, we get runs of one million vape pens or two million vape pens, et cetera, that really changes the efficiencies under which we can operate. So, it’s not necessarily just extraction versus white label..

And then is it fair to say that for at least the next several quarters, as all these customers are trying to ramp up and introduce various products, kind of like testing products out to see if this one works or that one works.

We’re probably going to see a lot more smaller runs still until they get a better handle on what works for them, upon which then they’ll start coming out with the bigger runs. So we’re still going to have that as a bit of a headwind, these smaller lot runs..

Well, I think there’s going to be a nice mix, because a lot of the smaller lot runs that we did sold very well in the market, and they’re really starting to – the scale of the orders that we’re getting are increasing on those items.

So you’re going to have that happening while we’re introducing a bunch of new brands and new company products under the market. So they will be smaller lot runs. And then – but you’re still going to have the base extraction, large run – large growth from LPs in terms of the flower production continues to come off out of the production facilities..

And you even seeing that on our on our staffing too, like even just the other day, we had our job fair for over 50 people. You’re seeing that demand. We’re increasing the shift amount. So we’re preparing for that right now..

Okay. And then just adding on to the question on the white label pipeline.

Can you give us a sense of – are the CPG players that you’re talking to in this pipeline starting to represent more than the traditional LPs? Or how is that pipeline mix looking from a traditional versus a new customer perspective?.

Well, it’s still hard to say John, because in terms of actual volumes from some of the CPG players, obviously, they hold their cards close to their chest in a lot of cases, and we’re continuing to work through the discussions with them. So pretty hard for us to say at this point.

But what I can say is that the volumes from that group will be expected to continue to accelerate as well the number of parties in that group..

All right. I think in some of your previous deck you had, you’re talking to 50 different potential white label customers.

Of those 50, for example, how many of those are more mainstream CPG versus just LPs that are looking to have a white label product?.

Well, you’re calling them LP. So I wouldn’t call them LPs. There’s a lot of non-licensed parties in that system, John, right? So, CPG companies, to me, I’m thinking of the large multinational/international companies, when you say CPG, but there’s a lot of branded companies that have limited product portfolios that are well positioned in their markets.

We have a lot of those conversations going on..

Okay. All right. Thank you..

And our next question is from David Kideckel from AltaCorp Capital. Please proceed with your question..

Thanks, guys. So, I just want to go back to talk about international a bit. I mean, you guys put out a really nice announcement, I guess, last week or a couple of weeks ago regarding the Australian deal you have in place there for medical cannabis. Just want to touch on how you see your strategy overall from international.

Are we still looking at having an EU GMP type model from your Kelowna facility and exporting that, whether that’s Europe, Australia, et cetera? Or is there – are there still ongoing opportunities that you’re assessing on an international basis with having some sort of physical presence in those regions?.

Both. so, I think the opportunity in the international market is very strong. In the short term, obviously, as we continue to bring on our K2 facility, EU GMP standards, we’ll be looking to get EU GMP certification there and servicing as much of the international market as we can to drive volumes and efficiency through that facility.

That just makes sense. But at the same time, we have a number of ongoing conversations in international markets, where, if we have the right partners and the right distribution opportunity and the right assets, there’s a transaction that we would look to do there as well.

So we’re really looking at it from a global infrastructure and efficiency perspective as opposed to just market-by-market review. So if we can service out of Kelowna and drive volumes out of there and good efficiencies, we will. If there’s other opportunities in markets, we’re not afraid to transact there.

But whatever we do, to be clear, there’s no big swings in our future. We’re not going to take a big swing at a large-scale acquisition or something. The market opportunities are good. But they’re small and they’re growing. So a right-size facility with the right amount of capital allocation is the way to play it..

Okay. Thanks very much. That’s it from me..

And this – we have reached the end of our question-and-answer session. And I will now turn the call back over to Tyler Robson, CEO, for closing remarks..

Thank you, operator. Fiscal 2019 was pivotal for Valens. We established ourselves as a go-to partner in the industry and provided our ability to execute on extraction contracts and produce high-quality white label products to support our customers’ brands.

Previously, Valens was best known as a leader in extraction, but with product development and manufacturing contracts now outnumbering extraction only contracts, it is clear, we are much more than that. Our rebranding as the Valens Company reflects the company’s evolution and expertise from extraction to innovation and next-generation products.

Now with the major expansion in the Canadian market as well as increasing global opportunity, we are well positioned to further grow the business and build the value of the company for the shareholders. Before we end today’s call, I’d like to thank all the shareholders for their ongoing support at this exciting time in our evolution.

With that, I’ll ask the operator to close the line..

With that, this concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation..

Thanks, everyone..