Scott Young - Head of Investor Relations Tyler Robson - Chief Executive Officer Chris Buysen - Chief Financial Officer Everett Knight - Executive Vice President, Strategy, and Investment

Greetings, and welcome to Valens GroWorks First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Scott Young of Valens GroWorks. Thank you. You may begin.

Thank you, Operator. Good morning, and welcome to the Valens GroWorks first quarter of fiscal 2019 financial results conference call. A replay of this call will be archived on the Investor Relations section of the Valens Web site at www.valensgroworks.com. 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@cdar.com. Any forward-looking statements should be considered in light of these factors. Please also note of the Safe Harbor any outlook we present 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. Everett Knight, Executive Vice President, Strategy, and Investment. With that, I would like to hand over the call to Tyler. Tyler, please go ahead.

Thank you, Scott. And welcome to everyone who has joined us for our fiscal first quarter 2019 financial results conference call for the three months period ended February 28, 2019. I'm excited to be here with you today. On our normal earnings I'll talk about our growth and development to-date, including some of our recent achievement and our outlook for the future. As Valens execute on the next stage of its evolution and transition into the high growth company, with the host [Technical difficulty] keep investors advised of our progress and answer any questions. I'm going to start today's call by providing some background on Valens and the steps we've taken to get us where we are today. I'll talk about progress of past year initiating ourselves into the cannabis industry and building what we believe is unique and dependable value proposition. I'll then set out some goals we're planning to achieve both this year next both before I ever talked about future strategy and Chris delves into the quarterly financials. Prior to this quarter, the majority of our focus has been on R&D investments, solidifying our extraction process and implementing initiatives to ensure we have a strong foundation in place on which to grow value to the business. These successful investments have enabled us to build out a diversified best-in-class extraction platform. As a result, we recently signed several multi-year extraction agreements with new clients and are part of our first meaningful sales in the most recent quarter. Revenues for Q1 2019 were $2.2 million when compared to nil in the same period of fiscal 2018 and $0.01 million in fiscal Q4 2018. Gross profit increased approximately $0.85 million or 38% of revenue for the first part of 2019 compared to nil in the same period 2018. We expect…

Thank you, Tyler. We are also diversifying our sources of revenue by performing formulation and product development services for our clients with cannabis operators increasingly asking for our guidance to determining which cannabis products they should produce. We’re able to help them formulate different products, such as vape-ins, edibles, concentrates, cannabis and food beverages, tinctures and capsules as they become available and tailor them to the specific requirements to the end consumer. In doing so, we are becoming a value creating service that drives our clients’ business strategy integral to their success. Currently, we are producing formulations for tinctures and two piece caps, and actively working to finalize various formulations for vaporizer cartridges, beverages and other innovative products to be able to white label and deliver to the market or industry partners in 2019. Crucially, we are able to perform our services at scale. In February 2019, we announced that we’ve expanded our annual extraction capacity significantly to allow for 240,000 kilogram of dried cannabis and campaign foot relative to 4,800 kilograms in March 2018, thereby securing our spot as a largest third-party extraction company in Canada. To put this into context, a 1 million square-foot green house could produce approximately 100,000 kilograms of dry cannabis flower, so our facility is basic leaders to a very significant portion of the market. Subsequent to quarter end, we increased the company's extraction, post processing and white label product development footprint from 25,000 square feet to over 50,000 square feet with the acquisition and expansion of 230 Carion Road and 180 Carion Road in Kelowna, British Columbia. The underdeveloped footprint of this 1.94 acre site will allow us to further expand to meet the growing demand for extraction services and product development expertise. Many of the cultivators in the market do not have…

Thank you, Everett. Revenue for the first quarter of fiscal 2019 is comprised of revenue from proprietary and industry leading extracting services, sale of cannabis and hemp biomass and analytical testing revenues from Valens lab. Revenue increased to $2.2 million in the first quarter compared to nil in the same period in fiscal 2018. This increase in revenue is due to extraction service revenue of $2.15 million, marking a significant milestone in the ramp of cannabis and hemp biomass for future processing. We experienced increasing size and frequency of shipment through the latter part of the quarter, which is continued to expand through the second quarter of 2019 as expected. In addition, the company generated approximately $0.14 million in revenue from analytical testing through the company’s ISO17025 accredited lab, including $0.7 million in inter-company testing revenue. The company did not generate any revenue from the analytical testing in the comparable period of fiscal 2018. Gross profit increased to approximately $0.85 million for the first quarter compared to nil in the same period in fiscal 2018. This increase in gross profit from extraction services for the three months ended February 28, 2019 was $0.77 million, or 36% compared to nil in the same period in fiscal 2018. The analytical testing operation also saw an increase in gross profit for the three months ended February 28, 2019 to $0.9 million or 69.7% compared to nil in the same period in fiscal 2018. Operating expenses for the first quarter were approximately $7 million compared to $3.8 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, as well as an increase in salaries and wages as the company scaled its operation to meet anticipated demand for services in…

. :

Everett, you did a nice job in aligning some of the international plans that you have. I want to focus a little bit on the U.S. first, and also congratulations on your -- the ETF listing on the HMUS being the sole extractor on that ETF. My question is now should we be thinking about your ability to extract hemp. Is that somewhere the balance will be shifting efforts into the U.S. specifically?

If you look, David, we're currently going to be the largest extractor of the hemp Canada and what we're seeing from our clients. And what we want to do is now take that proprietary technology we have here and take that, not just in the U.S. but around the world. We’re cognizant from a regulatory environment in U.S. that we would just be focusing on the hemp for CBD marketplace. But it is something we're currently evaluating today.

A follow on question here and then I will hop back on to the queue. Just going back to your white label plans here and in particular, you mentioned Tarukino, and that looks like it will be coming online by October 2019. Can you maybe give some guidance as far as some of your other white label products and which quarter of 2019 you expect those to come online in?

So David, we're currently producing in house both tincture bottle and 2P caps today. And what we're doing is expanding that further -- from an expectation standpoint, our concentration is on base hemp, and then we're going to do a select do edible and then cannabis and food beverages and with some tropicals. And we're going to give more guidance on that as we ramp up. We bought the facility next door and expanded our overall footprint to 50,000 and now is to build out our white label capacity. And if we get more indications on timing, we will get back to the street accordingly on when that will be ramping up. Just so you know, we currently do have testing for base hemp in house today in our [indiscernible].

And just to follow on to that then Everett and team, you mentioned as well. So you expect 2019 to be signing further contracts, so not only continuing to execute on the existing client contracts but new ones as well. Is there any guidance you can provide with how many contracts you're expecting, are these big LPs, the smaller LPs. Just I guess the total capacity we should be thinking about here?

David, currently, we have nine publicly announced contracts, five of being in the top 10 -- of the top 10 LPs in Canada. As that expands, as we sign these contracts we’ll obviously let the market know. But with moving forward all of customers come in different sizes. And what we want to do is to be the best platform not just for one just for all of them. We really want to diversify platform and doctors favoring one license putting to over another. So, it's very important. And think from a contract standpoint, you can expect them come in all sizes and we're continuing to ramp up trying to get more contracts in the next few months and obviously in 2019.

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

Just a couple of questions. Just looking at the some of the other markets, you did mentioned the U.S. But if we take a look at some of the European and other international market, are you being asked to follow some of your customers abroad to help them with their extraction capabilities?

Absolutely. If you look at the customers we have done publicly in Canada, those are the majority that drives moving very actively overseas. Some of them are asking us to follow them. We're going to be very strategic on doing that overseas but again it’s a little bit of different of an industry over there. But yes, we're being asked regularly to follow our partners, because we're so solid at what we're doing in Canada, it just makes sense for them to use this internationally as well.

And just when you initially looked at the market, Tyler, I mean, I think most people are looking at the extraction of trem and flower and everything like that from the cannabis plant. But as we move over into hemp that it becomes a large and growing market segment of the extraction industry. Is that going to eclipse or could the volumes eclipse what you do in flower longer term?

We are nimble in how we are moving forward. We have the ability to mass scale extract hemp and at the same time cannabis. So when you really look the line part of what went on in the U.S., U.S. has more potency hemp than we do. So right now, I would expect the Canadian market to mature and eventually hemp has more CBD content. So in time, I would expect more hemp to come in, because it is more cost-effective to grow. That being said as well -- there’s a lot of these greenhouses coming online, I would expect them to start producing mass scales. So I would almost think 50-50 long-term of what we will be extracting in Canada.

And what type of cannabinoid profile does the hemp have in Canada? I mean is it -- are we talking around 4% versus probably 10% in the U.S., and I guess that's going to be take a couple of years to get the [indiscernible] from here?

Yes, you are exactly right. For the hemp we're seeing is as low as 1% to as high as 5%. And if you look domestic U.S. it is basically anywhere from 8 to 12. So if you look at the throughput, we have to extract probably two or three times as much to get the same output essentially for the cannabinoid content. So yes, you basically hit the nail on the head. So in time I'm sure the landslide in Canada will change and it will mature to replicate what it's been in the U.S., so that 8% to 12% probably.

And just one final question on the white label. Are you going to be looking to partner with additional brands or maybe try to transition some brands over some of the gray market in order to facilitate maybe your vape pen or edible strategy?

We’re currently looking at doing that now like along with partnering not just the license producers, we want to be a white label manufacturer where either if you are a great market brand or you’re a CPG company or anyone else that want to produce the cannabis product in Canada, they can come to us on our independent platform where we’re not going to be competing with you. And actually producing customized that product and put it into the market and that’s exactly what we’re starting to do for some markets.

Our next question is from Neal Gilmer from Haywood Securities. Please go ahead.

Tyler, you had commented on briefly in your prepared remarks, so just maybe you want to expand on a little bit with respect to the gross margins and where they are in Q1 and expanding. Can you give us a little bit of color on where you see those expanding and what some of the factors are that are going to change how those gross margins come through?

Neil, as far as this quarter, we have 38% gross margin. As you look in the next few quarter, we expect that this expand significantly going into that as we go to more of a tooling base business, which is the majority of our focus. So as these tooling agreements come online, if you look at even extra [indiscernible] compliant in Q3 as those come online, I think what you’re going to see is that margin expand going in the next few quarters.

And then maybe just I know Tyler just commented when he was answering Craig’s question on the long term mix. But on the cannabis versus hemp in the short term, are you still primarily processing cannabis or are you starting to see more of hemp mix coming into your profile?

Right now, we’re seeing the majority of cannabis, particularly for the backlog that a lot of the top tier license producers had an inventory, so we’re still trying to burn through that as we move forward. But we are starting to see some hemp trickling and we expect Q3, Q4 to significant raise our hemp numbers for what we are physically extracting.

Our next question is from Martin Landry from JMP Securities. Please go ahead.

My first question is on your capacity. If we include the Hexo contract that’s announced this morning, wondering if you can give us an approximation of the percentage of your capacity that’s been contracted for physical 2020?

If you look at going into 2020, obviously, today capacity we have 240,000 kilograms. As we enter 2020 what we’re seeing from our customers is they’re all ramping up. And if they go above the minimum what we’ve trying to say to the market is that we would reasonably raise the money in general to expand our extraction capability to be ready for that. So going into 2020, we expect significant demand and it actually could be 40 to 240,000 kilogram we’re just waiting to see. And what we’re going to be do is be nimble and expand the capacity in the next few months, hopefully even to actually make sure that we are ready for that for our customers and that we have excess capacity, because we haven’t even -- like once we get in these white labeling and prudence et cetera and even signing new contracts, we will be needing more capacity as the demand ramps up.

So with your existing contracts announced, you could fill up your full 240 tons next year?

Yes, that’s what we're seeing from our customers. The reason we're expanding that further is we expect it to be larger in 2020 from a demand standpoint.

And you’ve announced several contracts on the extraction side. And I was wondering when could we see some announcements on white label products and services?

We're currently working through that right now, Martin. And if you look at some of the contracts, there is some white labeling and R&D associated with some of those contracts currently today. As that expand going forward, what we are going to do as we get more framework, we really want the framework from the government to get an IP of what that will look like. We’re currently preparing for that with our customer base and it’s getting ready for base cannabis and food beverages and different features as that ramps up. So I think from an expectation standpoint, I think its rapidly evolving and I will try to give more clarity as we get more clarity with the government regulations.

But just to be clear, is it safe to say that we’re going to see generate revenues from white label services and products in fiscal ’19?

Yes, absolutely. So we do have some agreement on the shelf ready to go. We're just waiting for the final rules and regulations from health Canada to make sure we basically launch those products under federal legislation. So we're ready to go. We're just waiting for health Canada to put the final stamp on it. But yes, you will see revenue in fiscal 2019 from our white label platform.

And last question, when you have discussions with your clients on these white label services. Where do you see the most demand in terms of product form? Just be curious to see what our clients asking in terms of white label services?

If you look at what's happening in more sophisticated markets in U.S., Martin, they have been a large portion of that market. And we expect that to expand based on the data we're seeing. And from a lot of the conversations, there's a lot of interest in data in general. And we plan to be the largest third party manufacturers of base hemp in Canada for our clients.

This concludes the question-and-answer session. I would like to turn the floor back to Mr. Robson for any closing comments. End of Q&A:

Thank you to everyone who has joined us on today's all. We will be doing these calls regularly going forward, and look forward to providing you with future progress on these. Before concluding the call, I would like to reiterate our overarching strategy, which is to position ourselves as part of the global cannabis industry by providing best in class extracting services and as accessing formulation and product development services. As a one of conduit between growers and retailers, we are integral to the cannabis supply chain and view down market positioning as acting to [indiscernible] base for Intel of Microsoft. Allowing us to benefit both from growth in the market by supporting rather than competing with the existing players, the key advantage to our business model is that we have multiyear contracts in place to give us revenue visibility for some of the most sophisticated license producers around the world. Our business is built on trust, quality and ability to execute. As a result of our initiatives over the past year, we're in an excellent position to accelerate our growth as we invest significant amount of money in our extraction facilitates to take. We're now at a point in our development where we have the expertise, infrastructure and scale in place to service our major extraction agreement. This has already led us to signing contract system in the industry to largest cannabis producers, such as Canopy Growth, Tilray, The Green Organic Duchman, Organigram and Hexo. Looking ahead, we will focus on executing on these contracts, as well as securing new clients while expanding our footprint globally as regulations advance around rolled off and right variable options for our customers on a larger scale. With the bulk of our infrastructure investment has already been completed, we will continue to invest in our processes and extraction capacity. We also plan to hire new team members to ensure we have the flexibility to adapt to the anticipated ramp in demand for new contracts without compromising on our optimal service. As Chris mentioned, we are well-capitalized to execute this strategy reporting $20.6 million in cash and short-term investments as of February 28, 2019, and completing $43.1 million bought deal financing subsequent to year end. 2019 will be the first year that we will generate meaningful revenue and we are already seeing that on our first quarter results. This is a very exciting and pivotal time for our company, and we expect to generate strong margins entering second half of 2019. With that, I'll now turn it back to the operator to close the lines. Thank you for everyone for taking the time to join us today.

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