Greetings. Welcome to the Valens GroWorks Q3 2019 Earnings Results 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] Please note this conference is being recorded. I will now turn the conference over to your host, Everett Knight, VP of Strategy and Investments. You may begin.

Thank you, operator, and good morning and welcome to the Valens GroWorks third 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 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. Jeff Fallows, President. With that, I would now like to hand it over Tyler. Tyler, please go ahead.

Thank you, Everett, and welcome to everyone who has joined us for our third quarter 2019 financial results conference call for the three months period ended August 31, 2019. When I co-founded this business several years ago, I set out to build the best-in-class, technically focused processing platform, capable of producing of broad portfolio of safe, consistent and innovative products and services to help our partners to differentiate themselves in the cannabis market. I believe that this time, as I still do, that this type of business model would allow us to generate sustainable, competitive, advanced and strong EBITDA margins over the long-term. Looking at our operational and financial results in third quarter, we are already beginning to see the benefits of this strategy. Despite this being new, only in the third quarter that we have been licensed to sell products and services into the market, we generated record revenue of $16.5 million. This represents an 87.1% increase over the second quarter and a 641.4% increase over the first quarter of 2019. Gross profit for the quarter was $12.8 million or 77.8% of revenue, compared to $5.1 million or 57.9% of revenue in the second quarter. Adjusted EBITDA was $9.8 million in the third quarter or 59.4% of revenue, compared to $2 million or 23% of revenue in the second quarter of 2019. We are very pleased with the margins achieved this quarter and believe that this gives the first look at the soundness of our strategy and earnings power of our platform. While we anticipate that our margins in future quarters will continue a strong upward trend from the levels seen in previous quarters, especially as our volumes continue to ramp and efficiencies are realized, margins in the third quarter were aided in part by a one-time contract opportunity,…

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 and then move on to our longer term and global vision to position Valens as the world's most trusted partner across multiple segments of the international cannabis supply chain. In the third quarter of 2019, 26,625 kilograms of dried cannabis and hemp biomass was processed by Valens, a 212% increase over the second quarter of 2019. We have already processed 13,423 kilograms of biomass in the first 45 days of the fourth quarter. During the early part of the quarter, we worked with a number of our clients to process smaller, higher revenue white label product lots in preparation for the launch of edibles and concentrates later this year. This is anticipated to result in higher revenue per gram of input in Q4 compared to previous quarters. Volumes are expected to accelerate in the back half of the fourth quarter, particularly as we begin to process larger white label lots for sale in 2020 and resume the processing of our previously announced contracted volumes. The growth and volumes in the quarter was driven by a continued ramp and services to existing industry-leading clients, such as Canopy Growth, Organigram, Tilray, and Sundial as well as first time revenues from new customers such as HEXO Corp. Our infrastructure continues to support an efficient ramp up and we're seeing these and other clients increase supply of dry flower and significantly expand their demand for distillate in anticipation of edibles and concentrates hitting the shelves in Canada later this year. This acceleration of demand is being expressed by both licensed producers and unlicensed branded product companies across the market and look set to continue into next year, particularly as the…

Thank you, Jeff. So quickly add to what Jeff said regarding vaping, while we continue to monitor market developments in this regard, we do not believe any of the current analysts estimates include a significant contribution from vape sales. Accordingly, we believe a vaporizer delay by Health Canada should any be forthcoming would not have a material impact on our ability to meet or exceed any of the current analyst estimates available. We can answer any further questions you have on the topic at the end of this call. Our capabilities extend across a number of extraction methods and are designed to produce a broad range of higher quality and more consistent end process. Not only have we developed what we believe is a first of its kind ethanol extraction line that utilizes equipment from around the world to efficiently deliver higher quality disciplines to our customers, we are also the only third party extractor with hydrocarbon extraction capabilities. Our diverse extraction platform allows us to provide a broad range of services throughout the supply chain including customized formulations, emulsion, terpene enhancements and centrifugal partition chromatography that will allow our customers to target specific cannabinoids for customized consumer experiences such as CBG, THCV or CBN, as well as separate out any unwanted containments in oil including pesticides and microbials. We are replicating the same diversification strategy in our white label business by building a broad IP portfolio for product development that spans all products from tinctures and beverages to topicals, concentrates and more. We are encouraged by the significant progress we are making in this area both building our product development portfolio and executing on agreements with industry leaders. Subsequent to the quarter end, we receive Health Canada authorization to manufacture and supply oil products directly to provincial distributors and…

Thank you, Everett. Revenue for the third quarter of 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 analytical testing revenue from Valens Labs. Revenue increased to $16.5 million in the third quarter, an 87.1% increase over the prior quarter's revenue of $8.8 million and a 641.4% increase over the first quarter's revenue. The third quarter's increase in revenue is driven by extraction service revenue of $16.4 million as the Company continues to scale its cannabis and hemp biomass received from industry partners for processing. During the quarter, we experienced an increase in order volume and frequency of shipments, which we anticipate continuing through the remainder of the year as we bring additional equipment online, including expanding our hydrocarbon extraction to meet this demand. Additionally, company generated $0.22 million in revenue from analytical testing through the Company's ISO 17025 accredited lab, including $0.12 million in intercompany testing revenue. Gross profit increased to approximately $12.8 million or a 77.8% gross margin for the third quarter, compared to $5.1 million or a 57.9% gross margin in the second quarter of 2019 and $0.85 million or 38.3% gross margin in the first quarter of 2019. As Tyler mentioned, the quarter-over-quarter strengthening in gross profit percentage was aided in part by a one-time contract in addition to our ability to realize increased efficiencies through the higher production volumes achieved in the third quarter. The gross profit from extraction services for the three months ended August 31, 2019, was 12.7 million or 77.3% gross profit compared to 5.1 million or 58% gross profit in the second quarter of 2019. The analytical testing operations saw an increase in gross profit for the three months ended August 31, 2019 to 0.15 million…

At this time, we will be conducting the question-and-answer session. [Operator instructions] First question comes from David Kideckel from AltaCorp Capital. You may proceed.

Hi, good morning everybody. Congratulations on your strong quarter. Thank you for taking my call. I had a few questions just to kick it off here. First just wanted to start with, as we know the derivatives legalization 2.0 markets becomes officially legal tomorrow. From a Valens perspective, where do you see the dollars per gram of revenue going as these edibles and concentrates come online?

So, David, it's Everett here. If you look at kind of what we've chatted previously is, we get like a, we have our contracts price in both input and output for extraction, and if we get kind of on average at dollar per cannabis on the extraction side and then we get $0.20 for hemp, obviously today, if you look at where that goes forward with edibles and concentrates when you're getting more dollars per gram, we see the current kind of dollar per gram expanding over the next few quarters and next few years as we ramp up and white label. And you're seeing us ramp up, even in the commentary, we did smaller lots and more focused on the derivative products that are coming to the market here shortly.

Thanks, Everett. So on that as well then, when we're going through our models, what should we be thinking about a potential split here versus cannabis versus hemp processing just to figure out you know, the actual dollar amounts?

So, if you look at for 2020 and you look at the 240,000 kilograms, we currently have contracted. I think a reasonable estimate today is 50% cannabis and 50% hemp. And when I will say is it's going to fluctuate quarter to quarter especially as hemp comes down in kind of the next few months here, I think that fluctuate just like any other agricultural crops, but overall from a 50-50 on that 240,000 kilogram is a reasonable estimate for now.

Okay, that's helpful. Thank you. And also, you've mentioned on your prepared remarks, you're in the process of switching a number of clients from tooling to white label. So just trying to get my head around, what do you think moving into the next two quarters, what's the split that Valens does between tooling and white label?

So, I think it's still ramping up and we'll get more clarity as we see, but I think that you're going to see that it's going to be more tooling for the next quarter for this quarter. But as you ramp up and you start to see more and more and white label coming online in Q1, Q2, I think you're going to see a significant shift kind of in the first half of next year. So we'll get more clarity on those numbers, but you're kind of seeing that how do you get these contracts come out just like a five year contract with Iconic, Shoppers and then Tilray and Tantalus. But as you see the products come to the marketplace, we can get more clarity on what that actual percentage split is.

Got it. Okay. Thank you. And my last question here for now and then I'll jump back in the queue. Is there any revenue guidance you can give The Street for the next quarter or two?

David, hi. This is Jeff. We're not giving any revenue guidance this time, no.

Our next question comes from Jenny Wang from Eight Capital. You may begin.

Congratulations on the quarter and thank you for taking my question. Just wondering, could you give us a bit of color on that 35 million hemp purchase agreement that you've entered into after the quarter. Are you moving towards more of a buy and sell model going forward? Or is this more of a one-time contract piece?

In the short term, that was a one-time opportunity. But clearly as we start to ramp up our white label activities that the sources apply will be a key component of that. So that is a good indication for you or how we're seeing the white label progressing to 2020.

Got it. And just moving on in terms of SG&A expenses for the quarter, there's a low Q2 [indiscernible] sales. Is this the level of OpEx that we expect going forward?

Yes, current levels will be indicative. I think what you're going to see though is, we're going to be continuing to scale the team here. As we mentioned in a number of announcements as the senior positions that we've announced, we're going to be continuing the role as to make sure that as we expand internationally, we have the infrastructure to support that growth.

And just following on that question, could you give us a bit of color on international expansion opportunities, and maybe what regions you're interested in, and also an update on the timing of these announcements?

Yes. So, these international expansions something that will, is an ongoing exercise for us. We're interviewing a number of conversations internationally. Even those conversations, we are working as a management team to prioritize in terms of the investment opportunity for dollars to maximizing our customer returns. We're also making sure that we have the right partners in those international markets because quite frankly we know how to extract and we know we've got a great platform that we can move internationally as we need to, but there will be the local partners that will be essential for us in terms of not only making sure we get those facilities for supply, but also making sure that the product that we're processing is making it into the market.

And just last one for me. I'll drop back in queue. Building on to David's question, on last earnings call, you've mentioned that white label revenues could eventually surpass extraction revenues as early as the second half of 2020 on a run rate basis. Is still the expectations or has anything changed there?

No, that's still the expectations.

Our next question comes from Colin George from Haywood Securities. Colin, you may proceed.

My question is with regards to the one-time contract that aided the margins for this quarter. Can you guys provide some clarity on the size of the quantum of what that contract contributed to revenue and this will be replaced on the quarters going forward?

We're not going to be specifically giving you guidance from the size of that contract, but what additional clarity I can give you with that. It was a customized extraction request, customized services with a very tight timeline for turnaround. So in that context, you were able to provide a premium. But in the context it didn't increase or necessarily grow the volume of processing that we didn't in the quarter, it was just a higher margin on that volume.

And then just maybe a follow-up to that question. You've mentioned that you guys have reported around 13 -- extracted a 13,000 kilograms in the first 45 days of this quarter that puts us on pace for a relatively kind of constant quarter-over-quarter growth. Do we expect that or see that same 90% growth filled in the back half of this quarter here? Or will be it slightly less quarter-over-quarter growth going forward?

Yes. So, I think if we are looking at the volume growth that is a 19% growth. We may not achieve that level quarter-over-quarter, but what you will see is on revenue per gram of input basis, it will be much higher than the current quarter.

Okay. Perfect. Alright, I'll jump back in the queue here. Thanks guys and congratulation on strong quarter.

Thanks.

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

Thank you, operator. Thank you to our shareholders for the ongoing support. Our success so far has been because of our targeted part of the value chain where we have world-class expertise. We come in everyday thinking how do we further help our customers to succeed in the fast growing market place. With our strong balance sheet, we are well positioned to continue to make strategic capital investment, both domestically and internationally in coming months. We continue to develop our expertise and extraction in white-label product development manufacturing, positioning the Company as the world's leading production partner in the cannabis industry. As we develop our unique IP based product technology platform, we expect to be able to meet the need of the growing industry and build Valens into a highly profitable global product development company for the cannabis and hemp marketplace. With that, I will ask the operator to close the call.

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