SNDL Inc. Q2 FY2020 Earnings Call

Greetings, ladies and gentlemen. And welcome to The Valens Company’s Second Quarter 2020 Financial Results Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. 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. Everett, please go ahead.

Thank you, Operator. Good morning. And welcome to The Valens Company’s second quarter 2020 financial results conference call. A replay of this call will be archived on the Investor Relations section of the Valens’ website at www.thevalenscompany.com/investors. Before we begin, please let me remind you that during the course of this conference call, Valens’ management may make statements including with respect to expectations or estimates of future performance. All such statements other than statements of historical facts could constitute forward-looking information or forward-looking statements within the meaning of the applicable securities laws and are based on expectations, estimates, and projections as of the date hereof. These forward-looking statements 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 the forward-looking statements, please refer to our latest annual information form filed with the Canadian securities regulatory authorities at www.sedar.com or on the Valens company’s website at www.thevalenscompany.com. The risks described in such annual information form are hereby incorporated by reference herein. Although these forward-looking statements reflect management’s current beliefs and reasonable assumptions based on current available information to management as of the date hereof, we cannot be certain that actual results would be consistent with such forward-looking information and we do not undertake to revise or update any such forward-looking statements in the future. We caution you not only to place undue reliance upon any such forward-looking statements. For a reconciliation of non-GAAP measures discussed, please consult our MD&A filed on SEDAR. 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. Welcome to everyone who has joined our earnings call to discuss our results for the second quarter that ended on May 31, 2020. As we navigate the unpredictable events of this year, I appreciate the chance to speak directly to our shareholders today and provide a corporate update. Later in this call, Jeff Fallows will give a more detailed overview of our recent operational achievements, while Everett and I will cover our accomplishments in capital markets, and Chris Buysen will present our financial results for the second quarter. First, I will recap our last quarter's performance and discuss the trends we are observing in various sectors. We are undoubtedly facing challenges that reflect global volatility and economic uncertainty stemming from this pandemic. However, I want to assure all of our shareholders that despite the current environment, we are focused on executing our corporate strategy, maintaining profitability, and forging strong partnerships that enhance the value of our platform and create long-term shareholder value. Revenue for the second quarter of 2020 was $17.6 million, representing a 100.3% increase from $8.8 million in the same quarter of 2019, but down 44.9% from $32 million in the preceding quarter that ended on February 29, 2020. Gross profit rose to $6.3 million, which is 35.8% of revenue for the second quarter of 2020, compared to $5.1 million or 57.9% of revenue during the same period in fiscal 2019. This was a decrease of 65.1% compared to $18.1 million in the previous quarter. Adjusted EBITDA was $2.7 million or 15.3% of revenue for the second quarter of 2020, up from $2 million or 23% of revenue in the second quarter of 2019 but down 81.1% from $14.3 million for the quarter that ended on February 29, 2020. While these results indicate a pullback from our previous five quarters of growth, they reflect the advancement of our strategic plan amid a challenging market landscape. Although demand for total extraction has been negatively affected by the current conditions, our strategic plan has remained unchanged. We have made considerable progress on developing our white label and custom manufacturing platform while also securing additional opportunities in this high-margin segment. This quarter, we saw a decrease in total extraction revenue linked to distillate product sales due to a slowdown in the cannabis sector, as we and our customers adapt to a more cautious spending approach, which we anticipate will continue into the third fiscal quarter. Nevertheless, we remain optimistic about the return of total extraction volumes since many of our customers hold large inventories of cannabis that they can better monetize by converting to oil-based products. In the second quarter, we directed our efforts toward extracting Valens-owned cannabis and hemp biomass, processing over 30,000 kilograms to prepare for expected inventory needs for 2.0 product offerings in the latter half of 2020. Increasing retail sales and numerous successful product launches across the country indicate market demand for more 2.0 products. Despite the challenges faced in the second quarter, The Valens Company has remained a preferred partner for many of the industry’s leading licensed producers and branded companies, as we possess the necessary capabilities to efficiently execute all phases of product development and supply chain. The rise in revenue from our custom manufacturing, white label, and co-packing agreements is projected to continue as both new and existing customers recognize the value of our platform. We currently have a strong pipeline to support the future launch of 2.0 products in the marketplace. A unique custom manufacturing agreement we signed after the quarter end is anticipated to drive considerable revenue growth for the second half of 2020. Throughout the second quarter, we continued to fulfill our existing contracts to support our customers as they launched more 2.0 product formats for Canadian consumers. Our internal record of launching a new product in 44 days highlights Valens' commitment to our partners and our efforts to gain market share with our value-added products. I will now pass the call to Jeff Fallows, President of The Valens Company, to delve deeper into our operational achievements this quarter, our outlook for the remainder of the year, and to share more details about how we are adapting to the current environment. I will be available to answer questions at the end of this call.

Thank you, Tyler. As noted, it has been a challenging quarter as several of our customers have experienced reduced workforces and decreases in cultivation output, which have resulted in a reduction in demand for our extraction services. With this in mind, we are cognizant of the need to run our company responsibly and are carefully monitoring our concentration risk, as well as the creditworthiness of our customers. We are also being selective in the extraction customers that we are onboarding. Overall, we believe that we are navigating the current market challenges successfully and are making solid progress in expanding our custom manufacturing and white label business segment, which is the key pillar of our strategy and is expected to be the primary driver of future revenue growth. We believe we have the most advanced and adaptable 2.0 platform in the market to manufacture innovative and differentiated products as demonstrated by our scale, diversity of our technical capabilities, and the quality of our products. This, together with the strength of our customer relationships, puts us in a strong position to be a leader in the industry even with the market challenges experienced over the past several months. As a result, we are expecting aggregate EBITDA growth to accelerate from current levels with the bulk of our growth expected to come in fiscal Q4 as a significant number of our new 2.0 products hit the shelves. While we are disappointed that the decline in revenue from extraction services has impacted our financial results for the quarter, we have made significant progress during this time to position our business to realize on the many emerging market opportunities we face. In addition to the white label partnership with A1 Cannabis Company, a subsidiary of Iconic Brewing, we continue to see growing demand for quality products in the market that have translated into signed customer agreements. Our customized offerings differentiate Valens in the market and enable us to empower our customers, gain market share, and expand our operations. We only expect this demand to grow as we bring hydrocarbon products including crumble, live resin, and other concentrates to market in Q3 and beyond. We are pleased that we have completed our first shipment of crumble at the beginning of July, the first ultra-premium concentrate offering in the country in partnership with Verse Cannabis. Our pipeline of manufacturing opportunities extends beyond Canada and we continue to engage in discussions with global players with a view to penetrating international markets and accelerating our growth as legalization spreads worldwide. We recently signed a five-year distribution agreement with Cannvalate, Australia’s largest medicinal cannabis distributor and clinical research organization. We see great potential in the Australian market, as it is currently the second largest cannabis market outside of North America. The partnership provides The Valens the platform to establish initial operations and pursue required licensing in Australia, bringing Valens high-quality oil-based products to a growing medicinal patient base and ultimately a broader consumer market. In the short term, we are focused on monetizing this agreement through the shipments of a broad range of products from our facility in Canada to Australia, which we expect to start in the third quarter of 2020, subject to receiving the necessary import and export permits. We are also in the process of finalizing a long-term lease on a property in Australia with a view to building out a manufacturing facility that will serve as the hub of our operations in the country and grow both in scale and capability as the market demand dictates. Construction on the facility is expected to commence upon the signing of the lease and is expected to be fully operational by midway through 2021, subject to applicable licensing and regulatory approvals. Our agreement with Cannvalate is an important step forward in our targeted global expansion strategy, which focuses on developing distribution channels and near-term revenue opportunities with shorter payback periods rather than an asset-heavy model. As discussed on our last call, we expect global cannabis revenue in 2020, with the potential for facilities on the ground internationally in 2021. Meanwhile, we have seen an uptick in demand for 2.0 products in Canada and have signed several new custom manufacturing partnerships to launch brand new products with leading brands. We entered into an agreement with TREC Brands to manufacture and sell vape pens as a new product format across three of their existing brands with potential for expansion to other products in the future. We also entered into an initial five-year manufacturing and distribution agreement with Verse Cannabis to develop a range of high-quality products such as concentrates, vapes, oils, and water-based products, leveraging technology sourced by Valens under two separate product lines. Both the Verse and TREC agreements allow for a royalty-based payment structure and are expected to generate long-term revenue for the company. Other recent milestones include the launch of our premium vape line made in partnership with the signing of an initial two-year agreement with high and new brands to develop and manufacture a premium line of vape products under the DAIZE brand portfolio, as well as a two-year agreement with FPS Brands to develop and manufacture a craft line of temporized CBD products under the ufeelu portfolio. As noted, we are pleased that despite the challenging market environment, we continue to hit many critical milestones in the strategic development of the company and have made material strides in growing our custom manufacturing segment with many more opportunities under negotiation. We will continue to accelerate the scale-up of our product development capabilities by developing additional intellectual properties to launch several new product formats. We have manufactured a record 36 SKUs that exceeded our estimate of 25 mentioned in the first quarter of 2020 conference call, leading to increased Canadian market share. The number of SKUs in development, as well as product offerings, are expected to increase throughout the second half of 2020 as our white label and custom manufacturing agreements grow and revenue from extraction contracts contributes to a smaller proportion of total revenue. I will now turn the call over to Everett Knight, Executive Vice President of Corporate Development and Capital Markets to discuss our capital expenditure plans in more detail and some of our other initiatives to bring value to our shareholders. Everett?

Thank you, Jeff. To begin, I would like to thank our shareholders for their continued support as we navigate these uncertain times. We are looking forward to the future as Valens' platform expands and gains continued recognition for the value-added manufacturing services we have already successfully integrated into the supply chain of many leading companies. We aim to continue to get the Valens name in front of the necessary stakeholders to not only increase our exposure as a third-party manufacturer but also to communicate the inherent potential we see in our business in the long term. In recent months, we have hit several exciting milestones that are aligned with our strategy to grow as a global cannabinoid-based product manufacturer, and importantly, deliver value for our shareholders. Our uplisting to the Toronto Stock Exchange on April 16th was a strategic move to support additional liquidity in our stock and broaden our reach within the investment community. We also successfully completed our continuance out of British Columbia to become federally incorporated as The Valens Company, a new name, which we believe better reflects the strategic vision and identity of the business. In addition to these milestones, I have seen our institutional research coverage expand. In order to strengthen our balance sheet, mitigate risks, and allow us to continue to focus on growing our core operation, we entered into a syndicated credit facility as announced earlier in June with CIBC and ATB Financial for up to $40 million of secured debt financing at attractive rates. This increases our confidence in our balance sheet and offers us a strong foundation that will allow us to leverage attractive investment opportunities as we emerge on the other side of the current market challenges. We believe our share price remains undervalued and in the second quarter, we started to buy back shares under our Normal Course Issuer Bid, as an effective and immediate way to return value for shareholders. The company acquired 43,600 of its common shares through a Normal Course Issuer Bid during May 2020 at a price range of $2.24 to $2.25 per share. The company will continue to evaluate the opportunity to purchase additional shares under the Normal Course Issuer Bid in the coming quarters and will continue to provide updates to shareholders. We are making crucial strides developing our intellectual properties that will support an attractive pipeline of opportunities. As Jeff mentioned, we are producing an ever-expanding range of SKUs, and our ability to efficiently and quickly turnaround new products is constantly improving. To support these efforts, we are increasing our manufacturing capacity at our facility in North Toronto, which upon completion we expect to be used in the production of beverages, edibles, and sourced products. We are currently on track to have this facility operational at the start of 2021. The construction at our K2 facility in Kelowna is almost complete and is expected to be operational in the fourth quarter of 2020. Once this facility comes online, we will add increased scale to a number of our manufacturing capabilities necessary to meet the 2.0 market demand. We are currently a market leader in the 2.0 cannabis product space, but with these expansions, we expect to truly become a premier Canadian manufacturer of oil-based cannabis products with the ultimate ability to distribute products globally. We have received the oil-based products market growing rapidly and we believe it will continue to eventually dominate the cannabis retail sales in Canada. We achieved our goal of reducing our accounts receivable balance in the second quarter. This is a result of the internal controls that management has put in place to facilitate appropriate payment terms and timeliness ultimately creating a win-win scenario for both parties. We are working hard to have our AR continue to decline in the coming quarters, ultimately reflecting a decrease in AR as a percentage of revenue. As always, communicating effectively and transparently with our stakeholders and shareholders, and maximizing return on invested capital remains core to our operating philosophy, we will continue to provide important updates to the investment community. Stay tuned. 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 industry-wide challenges driven largely by the COVID-19 pandemic as highlighted earlier in this call, consolidated revenue decreased $14.4 million or 44.9% to $17.6 million in the second quarter of fiscal 2020, compared to revenue of $32 million in the prior quarter ended February 29, 2020. Revenues were comprised mainly of proprietary and industry-leading extraction, white label, and custom manufacturing services, bulk winterized and distillate oil testing for the Cannabis 2.0 market, and analytical testing revenues. Revenue from the Cannabis operating segment decreased to $17.2 million in the second quarter of 2020, compared to $31.6 million in the prior quarter ended February 29, 2020. As a result of reduced shipments of biomass extraction, as our partners adjusted their workforce and operations to manage through the uncertainty created by the pandemic. In addition to a reduction in volume and compression in pricing realized on bulk winterized oil and distillate sales. We face a moderation in extraction volume and frequency of shipments to continue through the third quarter of 2020 but anticipate this production to be partially offset by growth in revenue from existing and potential new unlicensed white label and custom manufacturing partnerships highlighted earlier in this call. Additionally, in the second quarter of 2020, the company generated $0.7 million in revenue from analytical testing through the company’s ISO 17025 accredited lab, including $0.3 million in intercompany testing revenue, an increase from $0.6 million including $0.2 million in intercompany testing revenue in the prior quarter ended February 29, 2020. As Everett discussed earlier, the team remained focused on managing credit exposure with all customers. Trade accounts receivable decreased $12.4 million or 29.5% to $29.6 million at May 31, 2020, compared to $42.1 million at the end of the prior quarter ended February 29, 2020. Of these trade receivables, 85% are held with five Health Canada licensed customers of the company. Subsequent to the end of the quarter, the company has collected all trade accounts payable outstanding with the same partners or has recorded an impairment loss provision representing 53% of the trade receivable balance, which supports the cash position of the company and speaks to the strength of our current relationships with our industry partners. Consolidated gross profit was $6.3 million or 35.8% of revenue for the second quarter of 2020, compared to $18.1 million or 56.6% of revenue for the prior quarter ended February 29, 2020. Gross profit from the Cannabis operations for the second quarter was $6 million or 34.7% compared to $17.7 million or 56.2% in the prior quarter ended February 29, 2020. Gross profit was impacted in the second quarter of 2020 by a write-down of oil inventory of $1.5 million as a result of compression in pricing of bulk winterized and distillate oil. The analytical testing operation saw an increase in gross profit for the second quarter of $0.5 million or 69.7%, compared to $0.4 million or 72.3% in the prior quarter ended February 29, 2020. Operating expenses for the quarter were approximately $10 million, compared to $11.6 million during the prior quarter ended February 29, 2020. The decrease from the prior quarter was primarily attributable to lower wages and salaries as a result of the Government of Canada’s Canadian Emergency Wage Subsidy of $0.9 million, which was applied as a reduction to wages and salaries, lower share-based payments, and travel and business development as a result of travel restrictions in place due to the COVID-19 pandemic. These reductions were partially offset by higher professional fees and facility costs. Adjusted EBITDA was $2.7 million or 15.3% for the second quarter of 2020 and decreased 81.1%, compared to $14.3 million in the quarter ended February 29, 2020. For the second quarter of 2020, the company posted a net loss of $3.5 million or $0.03 per share, compared to the net income of $2.5 million or $0.02 per share for the prior quarter ended February 29, 2020. During the second quarter 2020, the company entered into a syndicated credit facility that will provide the company with up to $40 million of secured debt financing and interest rates ranging from prime plus 2% to prime plus 2.5% per annum depending on certain financial covenants. The credit facility consists of a $2 million secured term loan, which is fully drawn at May 31, 2020, and up to a $20 million secured revolving loan, which has not been drawn at May 31, 2020. In addition, the credit facility contained an accordion feature that could allow the company to increase the aggregate commitment by up to $10 million. The company had $45.1 million in cash and short-term investments as of May 31, 2020, compared to $44.3 million at February 29, 2020. With that, I will now turn the call over to the operator to open the lines for the Q&A.

Thank you. Our first question comes from the line of David Kideckel with ATB Capital Markets. Please proceed with your question.

Thanks, everybody, and congrats on the quarter. I just had a couple of questions here. The first I want to circle back on the expectations around tolling and extraction, obviously, a bit of a disappointment, which is not at all your fault coming from, I guess, many of the cannabis license producers. So I am wondering just from your expectations and how we should be thinking about this, given the great uncertainty with COVID-19 and the pandemic, and how this will further impact the LPs' ability to really come to you as a trusted provider to extract product? How should we be thinking about the ramp moving forward, not just in the next quarter, I mean, given that we are both halfway through this quarter already, but even into 2021, what are your expectations for tolling coming back and why as well? Thank you.

Thank you, David. This is Jeff. I will be managing the questions during this call since we are not all in the same location. I will address your question first. It's challenging for us to forecast what will happen next, especially considering the ongoing effects of COVID and the timeline for the return of extraction services. However, from a bounce platform perspective, we consistently provide the largest first-platform scale in the market to assist LPs and industry players with their needs. As we approach the end of 2020 and into 2021, we believe the cost efficiency and flexibility of our platform will be highly appealing when extraction margins and volumes regain strength.

Okay.

Yeah. And maybe just to expand. It’s Everett, David. As we discussed before, at Health Canada, of course, last week, there are 620,000 kilograms of dried cannabis inventory on licensed producers’ balance sheets. So it’s not like there is a lack of dry cannabis inventory. What COVID has done is put pressure on their balance sheets, and obviously, we are having conversations to get that back online. But if you just model out our manufacturing footprint today, the reason I view us more stable in this environment as a manufacturing company is really as we have gone and not only have licensed producers on our platform but as we have onboarded a whole bunch of these third-party players whether they are CPG companies, or whether they are brand companies that don’t have licensing, what we have been doing is we have been distributing those manufacturing products. And I think with the last four announcements recently along with BRNT now in Alberta you are seeing more visibility on that front on the platform and you are seeing that really translate through in the financials going from nine SKUs in Q1, so that’s 36 SKUs this quarter. And I would say just modeling that, we have an attractive platform and as these extractors come back in and figure out their balance sheets trouble, it’s just icing on the cake for us.

Okay. Thanks. That’s very helpful. Moving on to your white label segment and custom manufacturing, a number of the deals, if not all of them that have hit the wire over the last little bit, I think, 36 in total, I think, around four in the last six weeks alone, but there’s obviously a royalty structure in place here as opposed to the minimum supply agreements previously held as patrolling. I guess my question on the royalty structures, I am going to assume that you are not disclosing specifics, because you haven’t previously, but how should we be thinking about these royalty structures as far as each individual contract? Are these based from your uptake at the end of the bigger customer and it depends what sales they are bringing in which will ultimately drive your royalties, or is it based on the quantities regardless of sale that you are producing? Thank you.

The structure of these agreements varies from one customer to another. Generally, the more resources they contribute, such as a sales team, marketing platform, or established brand profile, the higher the royalty they will receive. Conversely, if we are doing more of the heavy lifting and our platform is central to the operation, the royalty will be lower. However, as those brands gain traction in the market and solidify their position, the financial arrangements could evolve as they demonstrate the ability to capture market share.

Okay, that’s good. If I can ask one more question, what kind of new products is Valens planning to ship out and to which provinces? Also, could you provide an update on the beverages, particularly regarding the source of those beverages? Thank you. That’s all from me.

Absolutely, this is Tyler. Looking ahead, a significant focus for us is vape pens. We believe we have the top product offerings in Canada, especially with the upcoming live resin. Another important area for us is beverages, as we are launching Drink Drop with one of our co-branded partners, which will be available in several provinces soon. Additionally, we are exploring other options, including hydrocarbon products, which we have officially launched in multiple provinces and are seeing great sales results. We remain optimistic about our SKUs and the products we offer, and we are also emphasizing white label and co-packing during this period to accelerate our growth.

Thanks for that, Tyler. And then maybe just a follow on that, from the beverage category, can you comment just overall how are you seeing sales within the beverage segments to date?

Overwhelming to say the least, so we knew beverages were going to be big, we didn’t know they would go as fast as they did, so we are firing on all cylinders, trying to reset the provincial demand and supply right now, which we have got to ramp-up our staffing and bring in more infrastructure and manufacturing equipment to try to ramp that up. So it is going better than expected and we will continue to kind of push that. With some key players actually having fundamentally sound beverages, we are one of the only ones out there actually creating a consumer experience with the accelerated onset and accelerated offset. So the feedback has been tremendous to date. So we are really going to take advantage of the unique opportunity we have.

Great. Thanks very much and congrats on the quarter.

Thank you. Our next question comes from the line of Jenny Wang with Eight Capital. Please proceed with your question.

Thank you. Good morning. My first question is, during the quarter you turned your focus to really produce and manufacture the 36 SKUs. I am assuming most of these are 2.0 products. Can you give us an idea to kind of what portion of these SKUs were for existing white label contracts that you have already secured and what portion was really in anticipation of signing future contracts? And the second part of this question is, would you consider directly selling maybe a part of these SKUs to provincial bodies under The Valens brand since you have already manufactured them? Thank you.

I will first address the second part of your question and then turn it over to Chris for the percentage details. We are a third-party custom manufacturer and currently have no plans to launch our Valens brand. Our focus is on enabling our current and future customers to differentiate their brands and introduce products to the market. Chris, could you provide insight on the sales breakdown?

Sure. Yes. Certainly. So, I guess, from a sales standpoint, as we enter into these relationships with these partners and licensed partners, the inventory that we are manufacturing really is specific to that partnership that we are creating with them, so all of the SKUs, the 36 SKUs that we manufactured this quarter would be for existing partnerships that were in place at that time, because it is a specific product that we are developing in partnership with each individual partner.

Okay. Got it. Thank you.

And Jenny, you should keep in mind as well that when you are announcing new agreements, we have a record where we launch a new product in 44 days into the market, but these things take a significant amount of time and effort internally to launch. So not only 36 SKUs is sort of a Herculean effort, but the next step in getting these new products to market on these agreements we just announced is also a lengthy process.

Okay. That’s helpful. And maybe in terms of could you give us some color on kind of reception of your delivered products so far, which categories are in demand by the provincial wholesalers and which categories do you think are still underserved or undersupplied by the industry?

Tyler?

The two main areas we see as underserved are hydrocarbons and beverages. We are struggling to produce hydrocarbons quickly enough, regardless of the extraction form. Regarding beverages, the consumer experience with many others has been disappointing, but the feedback we’ve received on our launch has been overwhelmingly positive. So, these represent the two biggest unique opportunities for us. Overall, I think the entire 2.0 category is underperforming compared to some of our industry peers, which presents us with a distinct opportunity. We genuinely believe that topicals will become a significant player, and we're focused on pushing that along with various hydrocarbon extracts. While we are emphasizing hydrocarbons right now, the overall 2.0 category needs improvement, particularly in terms of consistency, quality, and pricing that appeals to consumers. Many producers have raised their prices to cover production costs, which hinders their ability to compete effectively. By offering value-added services, we can penetrate the market and drive volume efficiently.

Got it. I will join back in the queue. Thanks.

Thank you. Our next question comes from the line of John Chu with Desjardins Capital Markets. Please proceed with your questions.

Hi. Good morning. Could you discuss pricing trends? There has been pressure on tooling, but I'm interested in broader trends affecting custom manufacturing and white label products. You mentioned being prepared to undercut prices, so should we expect to see similar pressure on the white label side?

I will start off by addressing your question, and then Everett can weigh in as well. John, what you’re observing is that our platform enables customers to build their brand in any segment they choose. They can offer premium products at higher price points when entering the market, supported by our infrastructure. On the other hand, for those seeking a more budget-friendly option, our platform accommodates that as well due to our capabilities. Overall, we're facilitating a variety of price points in the market. However, in the short term, the value segment seems to be gaining significant attention, and we anticipate strong growth in that area. Everett, do you have anything to add?

Yeah. John, I think, from the custom manufacturing side, it’s really a tailwind for us. If you look at the amount of dried cannabis in inventories earlier. In future quarters, especially going into 2021, I think, we can really, as we are selling mostly end products on the manufacturing side and distributing them. Our input cost is going down dramatically, right on that front every single day, which is really a tailwind for margin going into that 2021. So I think that’s an opportunity. I think, just to reiterate Jeff’s comments, we are the lowest cost producer as an extraction company in the cannabis space from our knowledge today. So I think that, yes, we have seen compression of oil sales, which is not as big of a core competency for us, we have already been more strategic on the custom manufacturing side, but the extraction footprint, I don’t think we are worried about the compression on that and we haven’t seen as much as on the distillate sale side.

And earlier you talked about just looking at the creditworthiness of customers and that’s an ongoing thing for the company. So maybe just give us an update in terms of the existing customer base, but also potential customers that maybe you had to turn away just because you didn’t think that their ability to pay down the roadways was quite up there. So maybe just give us a sense of how that’s been playing out for you?

Maybe, Chris, I will turn this over to you.

Certainly. Yeah. So, as we onboard and look at bringing new customers to the team from a control standpoint that is kind of one of the critical stages that we go through to evaluate creditworthiness of all of our partners on the white label side of things I guess it mitigated in the structure of those agreements from our royalty standpoint with us selling direct into the provinces kind of mitigate that risk in that category quite significantly. But on the extraction side specifically, definitely is a focus and something that the team looks closely at specifically in the environment that we are operating in today.

John, to clarify, the discussions are part of our pre-work to ensure we are comfortable with the profile. It's primarily focused on risk mitigation. When there are potential challenges with a customer, the conversation shifts to the deal structure and ways to limit risk and exposure, especially since there are ongoing challenges in the current market. Our objective is to bring brands to market, so we don't approach these conversations with the aim of rejecting people. Rather, we want to accurately assess the risk and ensure that our structure appropriately addresses that.

Okay. I will get back in the queue. Thanks.

Thank you. Our next question comes from the line of John Marrow with Canaccord Genuity. Please proceed with your question.

Good morning. Thank you for taking my questions. The first one here is just on the beverages and edibles categories. So we saw a report of strong demand for those 2.0 products as the stay-at-home measures came into place earlier. I think beverages and edibles are about 25% of sales in May. So as the summer months start rolling around, we are seeing these restrictions loosen up and people aren’t in home as much. So have you seen from your level of visibility any shifts on the demand or the market share side for these beverage and edible products? Are they trending upwards or downwards into the June, July summer months where people aren’t at home as much and they might be shifting more towards vape or bio type product?

I will let Tyler come in and comment on sort of a larger trend and view, but in the short term I will say, no, we haven’t noticed any decline. I think especially from the beverages perspective, it remains strong and growing. If I look at sort of the offering that we put on in the market relative to other markets where beverages are perhaps a lower percentage of the overall pie in Canada, given some of the technologies that we have out there and the quality of experience that we are providing, we continue to believe that that segment will be a larger segment in the Canadian context. But in the short term, we have not seen a shift in that demand so far. I don’t know, Tyler, is there anything to add?

Yeah. No. I will echo basically exactly what you said. So month-over-month growth as far as beverages, so a lot of people don’t understand like the core can take the beverages we put on the market so they are rather healthy, there is no hangover. So we see 10, 50 people actually moving away from alcohol into those beverages. And I can’t really comment on edible growth right now because that’s something we never really gone after. Looking after the health and wellness aspect that of the way trends are going in consumers right now not really a big aspect either at meeting drop or anything like that, so we really going after the low-core and take beverages and in the consumer experience. So we see nothing but blue sky going forward and really bringing different formats or different forms of beverages to the market, so the consumers can have options. Right now we only launch essentially 2 milligram and the 2.5 milligrams per serving. So you are going to see some other ones in the market in the very near future. So beverages are a whole team add in my mind.

And John, it’s Everett here. Maybe just to expand on that comment too, like that, we are impressed with the sales in May in Ontario that you said came from edibles and beverages. But if you look at that category of the edibles category, beverages made up 28%, and that’s the fastest growth we have seen. So as Tyler mentioned, we are seeing that growth continue and 25% of the Cannabis 2.0 category is way ahead of analyst estimates. I think what you are going to see that is if it’s continue to exceed those expectations, at least what we are seeing on our side. And if you look at the U.S. marketplace roadmap for Canada, it’s really a greater than 50% of the products now are oil based products, which is really our core competency as a manufacturer. So I think you are going to continue to see that growth and we continue to see that ramp up.

Thank you. I wanted to inquire about the Cannvalate agreement and whether there have been any discussions regarding bringing various products into Australia. Can you provide an update on how you are currently monetizing that agreement?

So we expect to have our first shipment, as we said, in the body of the call in Q3, our Q3, and we are very encouraged and very happy with the relationship we are building with Cannvalate and the opportunity that that is servicing for us. So right now, I’d say, definitely Q3 and then very excited about the opportunities to bring additional products on in the very good future.

Thank you. And just a follow on on that, is there a specific product format that they are looking towards, is it vapes or tinctures oil?

Sure. What it’s really starting like in the marketplace today if you look at Australia, it’s 95% oil-based products, right? So if you look at our market is dominated by tinctures, but soft gels are kind of fast coming up, I would say, that as we get into the CBD market place expanding, which is expected to be descheduled from Schedule 4 today to Schedule 3, we are going to see the variety of those products. So the conversation with Cannvalate, you would be surprised at the wide variety of products we are doing, not just tinctures, but beverages and topicals and vapes as that market expands. We are already having those conversations and got development plans in place.

Perfect. Thank you.

Thank you. Our next question comes from the line of David Kideckel with ATB Capital Markets. Please proceed with your questions.

Thank you. I just want to circle back on something, I mean, you guys have a solid balance sheet, great credit facility as well. And I think, Jeff you mentioned, that you believe that The Valens stock is very heavily discounted. We would agree with that too. My question is then on the before as you mentioned in your prepared remarks with the ramp of 2.0 products moving into the back half of 2020, I am just giving your ample liquidity here, is there an opportunity for you guys to be even more aggressive on your stock buyback? Thank you.

Certainly, David, and this is something that we discuss often and we balance against a number of opportunities. In the short term we are active but taking a cautious view of this given, we are very comfortable with our balance sheet, but we are very protective of our balance sheet and making sure that we continue to have the financial resources and flexibility to pursue the opportunities that are presented to us. But at the same time wanting to drive that near-term value or immediate value that gets delivered to shareholders through the buyback, so we have this conversation often, we will continue to be active, we will continue to pick our spots and not only supporting the stock but also driving value to shareholders.

Thank you.

Thank you. Our next question comes from the line of John Chu with Desjardins. Please proceed with your questions.

Hi. I wanted to follow up on the biomass processed during the quarter, which turned out to be significantly higher than we initially expected. Could you provide a breakdown of the hemp versus cannabis, and share your outlook for processing volumes moving forward?

Chris, do you want to take this one?

Certainly. So, yeah, if we look at the volume that we processed in May, as we mentioned in our commentary, a large portion of that was kind of shifted to our own biomass. As far as the split goes, it was fairly even between hemp and cannabis in the quarter, which aligns with kind of what we are seeing from inventory levels from our own internal inventory levels of CBD and THC, which we are kind of managing to be able to fulfill the demand that we are seeing for the white label products.

Okay. And then just another follow-up question, I thought, Tyler said on the call earlier that your entire margins are on the white label side. Can you just maybe go over the margin profile for custom manufacturing of white label versus the tooling? I thought that tooling was a higher margin business?

Giving your reference, Tyler. Tyler, do you want to take this one?

I can address that. The white label business is definitely a high-margin area for us. While the tooling business offers a higher margin percentage overall, we are still satisfied with the margins we are achieving in the white label segment.

And actually the market...

And John, just to be clear, if there was a comment or interpretation suggesting that we indicated the white label was a higher margin business, that was not the intention. We did not mean to say that.

Right. And that’s what I thought, that’s why I just wanted to make sure I heard that right to clarify that. And then maybe just describing the margin profile between the cannabis versus hemp based products, can you just maybe give us a little bit of an insight on that?

Sure. Chris, do you want to go through this one as well?

Sure. Can you repeat that?

I'm curious about the margin profile for a hemp-based product compared to a cannabis-based product. Are the margin profiles for white label similar, or is one higher than the other?

No. Overall, they are fairly similar and largely based on kind of these inputs that we are seeing from our biomass. We have been able to source recently some well-priced cannabis and we do have agreements in place on the hemp side as well for favorable pricing from our view. So, overall, similar margin profile between the two.

And sorry, Chris, maybe last question. Maybe just on the inventory, obviously, is there a risk of anymore write-downs on that? Thanks.

At this point in time, we are comfortable with the devaluation from an inventory standpoint. Again kind of continuing to monitor developments and compression that we have seen in pricing historically, but as we kind of shift and start to deploy this inventory into kind of consumer packaged goods through our white label program and being able to realize more value off of that, that will, I guess, further mitigate the risk of additional write-downs in the future as well.

Okay. Great. Thank you.

Thank you. Our next question is from the line of Jenny Wang with Eight Capital. Please proceed with your questions.

Thank you. I wanted to follow up on a comment made by Chris regarding opportunities to purchase dried hemp or dried cannabis at lower prices. What trends are you observing in wholesale prices? Are they decreasing significantly, stabilizing, or could you provide any insights on this? Thank you.

I believe there is downward pressure on pricing in the wholesale market, that's clear. However, we also see opportunities to make strategic purchases based on our relationships and the chance to acquire attractive products. This flexibility is one of the advantages of our balance sheet, enabling us to take advantage of lower price inputs. Chris?

Yeah. I wouldn’t have anything further to add to that. That’s definitely our strategy and what we are seeing in the market today for sure.

And Jenny, maybe just to expand, Everett here, I think that’s a tailwind, as I mentioned, long-term. Like, I think you are seeing a continual disproportionate compression on the dry cannabis with the inventories we talked about. And I think that’s in the future as we get more into the manufacturing side we have more stability and prices going into the provinces, meaning that if our input pricing comes down it goes into the margins for us. So I think that’s something to watch for, and as Jeff mentioned, we continue to have relationships and now that we are the biggest buyer of dried cannabis in Canada, I mean, we get very attractive pricing that I think would surprise you in the future.

Got it. Thank you.

Thank you. Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back to management for closing comments.

Thank you, Operator. As we continue to develop The Valens Company for a premium manufacturer in the cannabis space, we have diversified our business beyond total extraction and truly emerge as one of the only one-stop shops for product development and manufacturing cannabinoid based products in the country. We have put a dominant move in the creation of both the extraction and manufacturing marketplace, and continue to lead with the largest offering of extraction techniques and manufacturing and product format capability in the sector. We are not immune to the obstacles of building this nascent industry, which we undoubtedly have been impacted by the COVID-19 pandemic. So we believe the platform we have created is fully adaptable to the changing market conditions and as a result of the breadth of services we can offer. Further, we have made significant progress in the rollout of our white label and custom manufacturing program and believe this progress will lead to stronger revenue growth in the second half of the year and beyond as these customer agreements gain momentum. Our investments in proprietary technologies and our advancements in R&D capabilities are expected to further entrench our position as the leading producer of high-quality differentiated products and drive value in the months to come. In closing, I would like to thank all of our shareholders for their ongoing belief in our business allowing The Valens Company to grow as a pioneer in the industry, truly as the only third-party cannabinoid-based product manufacturing business today. The evolution of our business in the premier manufacturer has begun, and we are fully confident in the resources and capabilities we possess to lead on a global scale. With that, I will ask the operator to close the line.

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.