Earnings Call
SNDL Inc. (SNDL)
Earnings Call Transcript - SNDL Q1 2020
Operator, Operator
Welcome to the Valens Company First Quarter 2020 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. 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.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
Thank you, operator. Good morning and welcome to the Valens Company's first 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 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 AIF, 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 as of today and management does not undertake any obligation to revise any forward-looking statements in the future. For 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.
Tyler Robson, CEO
Thank you, Everett, and welcome to everyone who has joined our earnings call to discuss our results for the first quarter for the period ended February 29, 2020. I would like to begin by sharing our utmost support and solidarity to all the listeners and their families as we navigate this unprecedented time together. To the frontline workers, including those in our healthcare systems across the country and beyond, we thank you for your selfless dedication in helping us fight our way through this pandemic. We can control the overall impact this will have on our communities, businesses, industries, and overall society. Thus, we're focusing on what we can control, which is our commitment to working to protect communities by assisting where we can and ensuring those who require cannabis products and services can continue to access them both safely and efficiently. Bringing purposeful products to serve patients and consumers has been our mission since the inception of the company and is reflected in our recent rebrand which we announced in December. The end of Q1 has marked our first quarter as the Valens Company. Our rebrand represents much more than just a corporate name change; it signifies the evolution of our business into a leading cannabinoid-based product development and manufacturing company positioned to capitalize on the evolving industry on a global scale. Our rebrand reflects our growth and transformation over the past few years which culminated in us achieving a new strategic positioning for the launch of cannabis 2.0 and accelerating the scale-up of our white label capabilities during the first quarter. Revenue for the first quarter of 2020 increased to $32 million, a significant year-over-year increase from $2.2 million in the first quarter of 2019. Gross profit was $18.1 million, or 56.6% of revenue in the first quarter of 2020, compared to $0.9 million or 38.3% of revenue in the first quarter of 2019. Adjusted EBITDA was $14.3 million, or 44.7% of revenue for the first quarter of 2020, compared to a negative adjusted EBITDA of $2 million in the first quarter of 2019. We are pleased with these strong results which demonstrate the continued advancement of our growth strategy amidst the challenging market backdrop. The decrease in gross profit margin and adjusted EBITDA margin were expected as we roll out our white label program. This business segment offers greater opportunity to engage further with our customers who are looking to launch new and innovative product formats but bringing a more conservative margin profile going forward. With that said, we are expecting aggregate EBITDA growth to accelerate with the bulk of our growth coming in fiscal Q3 and Q4 as a significant number of our new products hit the shelves. We recognize that the COVID-19 pandemic is an evolving situation, and we are currently running our business with the health and safety of our employees as a top priority. Now more than ever, we are committed to remaining a valued and trusted partner to our customers despite the challenges we expect this market to bring. With this in mind, we continue to leverage the flexibility of our platform to create win-win scenarios in our partnerships. Managed contracts with extraction volumes month to month drive additional revenue through our white label program. We also recognize the urgency in preventing the transmission of the virus during this time and recognize the significant responsibility we have to ensure our communities are cared for. To help the nationwide effort to bring COVID-19 under control, we are using our existing extraction production line capabilities to distribute products that have the potential to fight transmission of the virus and alleviate essential supply shortages. We are bottling and donating 40,000 bottles of hand sanitizer in various formats to healthcare workers across Canada. We have also donated significant quantities of various personal protective equipment such as gloves, gowns, and sanitizing wipes from our existing supplies. We will continue to do everything in our power to support those on the frontlines in the fight against COVID-19. To our investors, I would like to reassure you that we are confident in the strength of our working relationships with our customers and our ability to service them in these difficult times. We will strive to continue to provide transparent, effective communications to all of you throughout the next several months as the situation continues to unfold. I'll now turn the call over to Jeff Fallows, President of the Valens Company, to dive deeper into our operational achievements in this quarter and the outlook for the rest of the year, as well as provide more details on how we're adapting to the current environment. I'll be available to answer questions at the end of this call. Jeff, over to you.
Jeff Fallows, President
Thanks Tyler. The first quarter of fiscal 2020 was a pivotal point for the Valens Company. In the midst of a challenging market environment, we continue to hit many critical milestones in the strategic development of the company. We believe our efforts in this quarter will present significant revenue opportunities later this year and beyond, and have greatly furthered our goal of being a leading cannabinoid-based products company delivering next-generation products to our customers. I'm going to start by recapping our achievements in the first quarter and talk about the trends we are seeing in the cannabis market, before going into our outlook for the remainder of the year which will include the initiatives we've put in place to adapt to the COVID-19 pandemic and the impact we are seeing so far. Throughout the quarter, we leveraged the flexibility of our extraction platform to help our customers navigate increasing complexity in the market while at the same time accelerating the scalable white label capability. These efforts included launching a number of new product formats such as hydrocarbon-based offerings with the intention of bringing these high-demand products to customers at the beginning of the third quarter. As a result of these efforts, we now expect white labels to exceed over 50% of revenues in Q3 2020 earlier than our previously expected timeline of Q4. We processed 19,962 kilograms of dried cannabis and hemp biomass in the first quarter of 2020. In line with the trends identified on previous earnings conference calls, our processing volumes remained flat as our production mix shifted to a number of smaller outruns in order to help our customers launch a broad assortment of products into the cannabis 2.0 final market. This transition also resulted in an increase in our revenue per gram of input to $1.44 per gram in the first quarter of 2020 compared to $1.25 per gram in the fourth quarter of 2019 and $0.61 per gram in the third quarter of 2019. Revenue per gram is expected to continue to increase throughout 2020 as a number of white label contracts continue to grow and revenue from extraction contracts returns to grow but contributes to a smaller proportion of total revenue. The company has 25 SKUs across five different product lines in its development pipeline and expects this to grow throughout 2020 to meet demand from its customers for cannabis 2.0 products including vape pens, edibles, concentrates, cannabis-infused beverages, topicals, tinctures, and capsules. As the industry matures not just in Canada but globally, part of our strategy to produce differentiated, innovative, and high-quality products is to acquire and develop proprietary technologies for the customized delivery of cannabinoids. During the first quarter, we expanded our exclusive license for the SoRSE by Valens emulsion technology to include Europe, Australia, and Mexico in addition to Canada, representing a nearly 20 times increase in the available population exclusively available to Valens and its customers. This was followed in late February by the announcement of our first international shipments of white label products to customers in Australia. The initial shipments will consist of three SKUs of tinctures totaling over 3,000 units and are expected to be shipped in the coming months pending receipt of necessary import and export permits. During the first quarter, we also signed a multi-year extraction white label agreement with Emerald Health Therapeutics and a multi-year product supply agreement with Dynaleo. In addition to extraction services, Valens will provide Emerald Health, one of the leading players in the medical market, with white label services including formulation, mixing, and filling for beverages, soft gels, and tinctures. We are looking forward to helping them expand their product portfolio over the course of the year. Dynaleo has agreed to purchase a minimum of 40 kilograms of THC or CBD in year one and two of their contract in either distillate or SoRSE by Valens Emulsion, followed by 50 kilograms and 75 kilograms in the subsequent years for use in the production of edibles. Most recently in Q2, we launched cannabis-infused beverages through a white label partnership with A1 Cannabis Company, a subsidiary of Iconic Brewing, which were first to market in Ontario. The demand for quality products is becoming increasingly evident in the market, and we are proud to be able to differentiate ourselves with our innovative offering, enabling us to capture market share and empower customer brand development in a strict regulatory environment. In particular, we believe that Isolate will continue to gain traction and that future demand is currently underestimated. Our process allows for the manufacturing of very high purity of Isolate which speaks to our advanced technologies and positions us well to take full advantage of this emerging market opportunity. This will leave the further development of our white label product offering for both our licensed and unlicensed CPG customers. Now I'd like to move on to the current market volatility and give some further color on the impacts we're seeing on our business in Q2. Like many, we are seeing challenges in the current market environment with several of our customers experiencing reduced workforces and temporary decreases in cultivation output which have resulted in reduced demand for extraction services. Retail demand for cannabis has surged during the COVID-19 pandemic and while we are currently anticipating strong white label sales going into the second half of fiscal 2020, we are currently unable to predict the full impact these market challenges will have on our second quarter result. That being said, we continue to benefit from the flexibility of our platform, the quality of our output, and the experience of our team in assessing opportunities both in the near and longer term. With a breadth of new products on the horizon, our white label platform that surpasses even the largest Canadian cannabis companies, a diverse customer base, and early signs of extraction volume recovery, we are well-positioned to adapt to the ever-changing environments and consumer demand. Our strong cash position does not leave us complacent as our team looks to maximize capital allocation to generate the highest return on invested capital for our shareholders. As Tyler mentioned, we cannot control the overall impact of a pandemic but we can remain focused on the factors within our control. With this in mind, we are taking a five-strong approach to navigate the current environment. First, maintaining the health and safety of our employees is paramount. Secondly, ensuring adequate supply of critical business input to drive production. Third, identifying, communicating, and executing on business priorities. Fourth, eliminating or delaying all lower priority projects and expenditures, and fifth, opening appropriate communication channels to ensure all of our stakeholders stay informed about our progress. In the near term, we have turned our focus to our domestic operations and have temporarily slowed our international expansion efforts as a result of the global impact of the pandemic. This focus includes getting our K2 facility in Kelowna and our Greater Toronto Area operations up and running and continuing to further our IP development activities. While we remain confident in our balance sheet, we believe this is the correct course of action in the short term, mitigating risk, allowing us to focus on our core operations and potentially setting the stage for even more attractive investment opportunities as we emerge on the other side of the current market challenges. I'll now turn the call over to Everett Knight, Executive Vice President of Corporate Development and Capital Markets, to discuss our CapEx plans in more detail and some of our other initiatives to bring value to our shareholders. Everett?
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
Thank you, Jeff. As our company grows, we recognize the increased responsibility we have to communicate both effectively and transparently to the investment community. Given the heightened levels of uncertainty in the market, this is now even truer than it ever was before. Our philosophy has always been and will remain to maximize return on invested capital for our shareholders. It is shown 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 during this period of market uncertainty. With recent events and large stimulus packages being issued by countries around the world, we believe this may accelerate cannabis legalization as governments look for tax revenue in future quarters and years to come. Although Jeff mentioned that we are temporarily slowing our global expansion efforts in this environment, we have expanded our international team and will be opportunistic in targeting strategic, undervalued assets that we can acquire at a discount in future years. With that said, we still expect global cannabis revenue within 2020 with the potential for facilities on the ground internationally in 2021. We continue to focus largely on intellectual property-related initiatives as we see an increasingly attractive pipeline of opportunities that we can leverage throughout our growing global platform. From an investor standpoint, we have hit many significant milestones in Q1 that we expect will help us increase the liquidity of our stock and enhance shareholder value, including securing DTC eligibility for our shares traded on the OTCQX. This will bring us closer to increasing trading volume and liquidity in the United States and allowing us to reach new investors in larger markets. We also announced a normal course issuer bid in the quarter allowing us to purchase and cancel up to 6,275,204 of Valens common shares through open market purchases from time to time, which will be funded with cash on hand. We have not yet purchased any shares under the normal course issuer bid but intend to be more active in the coming quarters as allowed by the plan and as appropriate in the market. Most recently in Q2, we announced that we received conditional approval on March 25 to graduate from the TSX Venture to the Toronto Stock Exchange, another major milestone in our plans to bring value to our shareholders as we gain access to a wider group of investors, indexes, exchange-traded funds, as well as analyst coverage opportunities. And now we are excited to announce that on April 14, we were recently granted official approval by the TMX to trade on the Toronto Stock Exchange this Thursday, April 16, under the ticker symbol VLNS. Our belief is that company fundamentals, including cash flow generation, will be the main driver of long-term shareholder value. However, with these major milestones in place, we have increased our ability to reach new sophisticated investors, not only as a profitable company but as a leader in the cannabis space. As discussed in our last conference call, we are working towards increasing our manufacturing capacity at our Pommies facility north of Toronto and we are budgeting for approximately $10 million of capital expenditures at that facility. Once complete, we will ramp white label activities for beverages, edibles and SoRSE by Valens in the Greater Toronto Area starting at the end of fiscal 2020. The planned capital expenditures to bring the facility into full operation are fully funded with cash on hand. The K2 facility in Kelowna is on track to ramp up operations in the second half of 2020. Once this facility comes online, it will expand our 425,000 kilogram extraction input significantly and add increased scale to a number of our manufacturing capabilities in the second half of 2020. With that, I will now turn the call over to Chris Buysen, CFO, to talk about our financial results.
Chris Buysen, CFO
Thank you, Everett. Based on the operational achievements highlighted earlier in this call, consolidated revenue increased to $32 million for the first quarter ended February 29, 2020, a significant increase from $2.2 million in the first quarter of 2019. Revenue is primarily from proprietary and industry-leading extraction and white label manufacturing services, oil and oil-based products aimed at the cannabis 2.0 market, and analytical testing revenue. Revenue from the cannabis operating segment rose to $31.6 million in the first quarter of 2020 compared to $2.2 million in the same period of 2019. The company continues to focus on processing cannabis and hemp biomass, sourcing both winterized and distillate oil for our partners' cannabis 2.0 products and scaling up white label product formulation and manufacturing to include tinctures and beverages. During the quarter, we experienced a moderation in extraction volume and frequency of shipments, which we expect to continue into the second quarter of 2020 due to the current operating environment, with several customers facing reduced workforces and temporary decreases in cultivation output as a result of the COVID-19 pandemic. Looking ahead to the back half of fiscal 2020, we anticipate extraction volumes to strengthen as additional equipment comes online, including an expansion of our hydrocarbon capabilities. In the first quarter of 2020, the company generated $0.6 million in revenue from analytical testing at the company’s ISO17025 accredited lab, including $0.17 million in intercompany testing revenue, marking a significant increase from $0.1 million in the first quarter of 2019. With our continued revenue growth in the first quarter and the timing of certain sales of oil and oil-based products intended for the cannabis 2.0 market, customer trade receivables increased to $42.1 million at February 29, 2020. Of these trade receivables, 67% are associated with five Health Canada licensed partners of the company. To provide additional context on our accounts receivable aging, based on our agreements with license partners, we expect to collect outstanding receivables within 30 to 90 days. Following the end of the quarter, we are pleased to report that we have already collected or have trade payables with the same partners for 54% of these receivables, which supports our strong cash position and reflects the strength of our current relationships with industry partners. With revenue from branded customers expected to surpass licensed partner revenue later in the year, we foresee revenue collection becoming more stable as provincial retailers constitute a larger part of our customer base and our platform diversifies. Consolidated gross profit increased to $18.1 million, or 56.6% of revenue, for the first quarter of 2020, up from $0.9 million, or 38.3%, for the same period in 2019. The gross profit from cannabis operations for the first quarter was $17.7 million, or 56.2%, compared to $0.8 million, or 35.9%, in the same period of fiscal 2019. Gross profit margins for cannabis operations were affected in the first quarter of 2020 by a write-down of inventory amounting to $2.4 million related to cannabis purchased and processed, as the cost of these specific inventory losses exceeded the net realizable value. Before this inventory write-down, cannabis operations had a gross margin of 63.9% of revenue in the quarter. The analytical testing operations saw gross profits increase in the first quarter to $0.4 million, or 72.3%, compared to $0.1 million, or 69.6%, in the same period in fiscal 2019. Operating expenses for the quarter were approximately $11.6 million compared to $7 million in the same period in 2019. The increase from 2019 is mainly due to higher depreciation and amortization costs, salaries and wages, and research, extraction, and lab costs tied to the company's expanded operations to meet service demand in 2020. These increased costs were partly offset by lower share-based payment and advertising costs in the first quarter of 2020. Adjusted EBITDA was $14.3 million, or 44.7%, for the first quarter of 2020, compared to a negative adjusted EBITDA of $2 million in the first quarter of 2019. The company recorded a tax provision of $0.3 million in the first quarter as profitability increased, with one of the company’s entities remaining taxable after utilizing all available non-capital loss carryforwards. The company continues to implement strategies to effectively manage its overall tax structure and reviews this structure regularly. For the first quarter of 2020, the company achieved a net income of $2.5 million, or $0.02 per share, in contrast to a net loss of $6.4 million, or $0.07 per share, in the same period of 2019. The company had $44.3 million in cash and short-term investments as of February 29, 2020, down from $58.7 million at November 30, 2019. With that, I will turn the call over to the operator for the Q&A.
Operator, Operator
Thank you. At this time we'll be conducting a question-and-answer session. Our first question comes from the line of David Kideckel with AltaCorp. Please proceed with your question.
David Kideckel, Analyst
Good morning. Congrats on the quarter guys and thanks for taking my questions here. A couple of questions for you. You mentioned both in your press release and also you alluded to your prepared remarks this morning while the COVID-19 pandemic brings some uncertainty to your next quarter, I'm just wondering how you're gearing up and preparing for the uncertainty in Q2 and really being able to deliver in the next subsequent quarters; Q3 and Q4.
Jeff Fallows, President
Sure David. This is Jeff. I'll take this one and just a note for the call, I'll be directing all the questions to members of the team, just to make sure we're efficient. We're not talking over each other, but if you have specific people that you would like to target your questions towards, please feel free to do so. Today, as I said in my comments, the scripted comments for the beginning of the call, the first step that we looked at in assessing what we should do in the context of the market was, first and foremost, make sure our employees are safe and secondly that we had all the critical business inputs and supply lines we needed were in place to make sure we continue to operate. The next part of that strategy was to then take a look at our plan for the year and strategize around which were the appropriate priorities in the context of what we were seeing in the market. So at the end of Q1 and into Q2, as we said in our remarks, we started to notice that slowdown in our extraction services and then decided to pivot our efforts to the white label program. Remember that we had originally anticipated that base extraction would represent the majority of our revenue for the better part of 2020, but in light of the slowdown, we ramped up activities in our white label and now believe that those efforts will pay even more dividends later in the year. The white label program will represent a larger part of our revenue much sooner than originally anticipated. This includes things like our hydrocarbon extraction, a broader portfolio of other white label products, and bringing isolate in larger quantities to the market.
David Kideckel, Analyst
Thanks for that Jeff and just to follow on with a question unrelated here, with respect to the accounts receivable, I mean accounts payable, we do know that they both increased in this quarter. So I'm just wondering if you can shed and I know Chris you gave some color on this but are you able to shed some more light on that?
Chris Buysen, CFO
Yes, certainly. So I kind of, as my remarks earlier in the call and as we disclosed in our financial statements, our receivables are comprised of 67% of them made off with our five largest partners. That balance of 55% of that balance we were able to collect after the quarter. We know that's a little bit lower than what we received at the end of Q4 and largely just based on the timing of when we reported Q1 and we had more time obviously between the end of Q4 and when we reported our year-end results. So as far as our overall philosophy and strategy with respect to receivables, we're very proactive in how we're looking at those managing those relationships on a daily basis. As part of our review for the quarter, we did provide a provision of $358,000. We see that currently as our exposure at this time. We haven't worked with a lot of our partners around timing of payments, and have extended some payment terms with some of our partners. Through that process, we haven't had any of them miss, and they continue the commitments they made with respect to the payment obligations that we have set up. So we don't foresee any additional risk with respect to those balances at this time.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
And David, it's Everett. Just a follow-on, from an expectation on a modeling standpoint, like for all of 2020, we're forecasting that every single third-party customer is under 10% of our forecasted revenue. So the diversification that Jeff talked about in the opening remarks will continue to be a strength for us going forward, as well as branded products. These third-party partners, we have a licensed producer category, then we kind of have the branded products category where we have CPG customers like Iconic, BRNT, etc. We continue to see a lot of demand growth on that. If you look at our expectations and forecast for Q3 and Q4, our branded products actually exceed the revenue from the licensed producers, and we're paid by the provincial retailers in that case where we get the revenue and then we actually pay a royalty back to those licensed partners. I think that’s a more stable environment and diversified into the back half. From an AR as a percentage of sales, you're going to see that come down here significantly as we have that diversity going into the back half. Just for your modeling and just to understand the provincial payment dynamics for investors, currently province is on average paying after 60 days. So our customers get that money, and then pay us, but that means that we're getting paid between 60 and 90 days for a lot of those customers. Therefore, that's why the receivables are coming in at that time, not because, as Chris mentioned, they're late on payments; they've been timely on those. Just for your expectations on modeling going forth.
David Kideckel, Analyst
Very helpful. Thank you for the color, and I will hop back into the queue.
Operator, Operator
Thank you. Our next question comes from the line of Neal Gilmer with Haywood Security. Please proceed with your question.
Neal Gilmer, Analyst
Yes. Good morning guys. Maybe one to start off with your comments on the revenue program. Obviously, you've had a very noticeable increase from Q3 through Q1 of this fiscal year in your comments that you expect to trend higher. Can you provide any sort of color on whether you expect the same sort of rate of growth or is that going to sort of moderate as we move through 2020?
Jeff Fallows, President
Yes. Thanks Neal. Maybe I will take this one and then others can add on to the back. Right now, as we look forward, it's a little too early for us to really have a great sense on exactly where that revenue program is going to go. Obviously, it's going to depend on our product mix. Different products will deliver different revenue program dynamics. We appreciate from an investor perspective and from an analyst perspective that you're going to need additional color on how to forecast this plan going forward, and as trends in the market develop, we fully intend to help with better guidance in that regard. In the short term here, we're still trying to get a better handle on what products are going to be driving, which demand as we move through the 2020 year.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
And Neal, it's Everett. Let me add that I reiterate what Jeff said; it's tough to model today, but you can expect that with more white label products in Q3 and Q4, and as they become a larger portion of our revenue stream, that dollar program will naturally increase. Different products have different dollar programs, with beverages being a really high dollar program while others vary. As more white label products become available, we expect that to increase over time.
Neal Gilmer, Analyst
Okay. Thanks, guys for that. Maybe just on the expansion in Kelowna, I think in your prepared remarks you commented on it being complete or being operational in the second half of ‘20. When that comes online, obviously it increases your capacity. Does it have any change or impact on your cost structure for your operations at all?
Jeff Fallows, President
Obviously it is. This is Jeff. Maybe I'll start with this one and then others can jump in. As your volume increases, your efficiency increases, and with the additional facility online, we do expect that we'll be able to run larger lots, which will help to spread the production platform over a larger area. That should drive efficiencies for us, but again, it will depend on the product mix coming out of there and how that demand fills up that facility over the course of 2020.
Neal Gilmer, Analyst
Great. Thanks very much, guys.
Operator, Operator
Thank you. Our next question comes from the line of Jenny Wang with Eight Capital. Please proceed with your question.
Jenny Wang, Analyst
Thank you. Good morning. My first question, Everett, you mentioned that you’re expecting branded partners to succeed licensed producers in the second half of 2020 in terms of revenues. Is this under the expectation that you will find new partners or mostly existing partners increasing their volume?
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
So thanks for the question, Jenny. It’s both. We expect you're going to see growth on both sides in our number of contracts expanding and the existing partnerships we have will scale and grow product offerings increasingly on those platforms. So, it's a two-pronged answer.
Jenny Wang, Analyst
Got it. Thank you. And then just in terms of your inventory on hand, I'm just wondering what's the kind of the average shelf-life of the inventory given the COVID potentially creating a slowdown. Are there ways to extend that shelf life or mitigate any inventory expiring?
Jeff Fallows, President
Everett?
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
Yes. The inventory obviously increased this quarter. That's in preparation for the 2.0 products. We are obviously gearing up for more branding sales, especially if you look at hydrocarbon; you need specific inputs. With hydrocarbon, you need a higher terpene profile in the actual cannabis itself. So it's important that we supply that now and get ready. We're not taking on ongoing price risk for our customers. Which has worked out really good in this environment. As for the stability of the products long-term, dried cannabis has a shelf life of three to six months, with degradation over time. Oil, in distillate, sees way less degradation. People have held it on hand for years in this industry. So as licensed producers, I think there's over 400,000 kilograms of dried capacity on people's balance sheets. They have to make a decision; either they let that expire or they turn it into distillate and actually get a longer shelf life, which is an opportunity for us as extraction volumes start picking up in Q3 and Q4. We are already seeing conversations with some of our customers where they're planning for that as 2.0 products ramp up.
Jenny Wang, Analyst
Got it. Thank you. I will jump back in the queue.
Operator, Operator
Thank you. Our next question comes from the line of Paul Piotrowski with M Partners. Please proceed with your question.
Paul Piotrowski, Analyst
Hey guys. Thanks for taking my question. Just a quick point on the inventory. So in preparation for hydrocarbon and all that heading into the back half of 2020, are we at normalized levels now? Do you feel like you need more on hand?
Jeff Fallows, President
Sorry this is Jeff. So maybe I will take this one. It's going to depend on the opportunities we see for our pricing of product that we are looking for in our demand profile as it continues to grow, but I think current levels should be pretty steady going for the next several quarters. As demand continues to grow, it may have the potential to increase, especially as our volumes increase.
Paul Piotrowski, Analyst
Okay. Great. And then just a quick one on Pommies, so I don't know if I missed it but can you give the timelines we have on CapEx at that facility?
Jeff Fallows, President
Yes. As Everett said in his remarks, we are forecasting around plus or minus $10 million in capital expenditures to bring the facility online, and that will largely take place over 2020.
Paul Piotrowski, Analyst
Okay. Great. That's it for me, thank you.
Operator, Operator
Thank you. Our next question comes from the line of John Chu with Desjardins Capital Markets. Please proceed with your question.
John Chu, Analyst
Hi, good morning. So my first question is just on how moving towards white label is changing the payment dynamics. You're getting paid from the Provinces, you said. So I am just curious if there's any risk to what we've seen going on in the LP side where receiving some sales being returned, sales returns provisions, price adjustments, and whatnot. Are you at risk of that, given that the payment is coming from the Provinces now?
Jeff Fallows, President
Maybe, Tyler will give you a chance to jump in here.
Tyler Robson, CEO
Yes. Absolutely. Chu, this is... it's a loaded question because at the end of the day, we don't have a solid answer yet. We haven't seen any return product or any issues yet, but obviously, it's something we need to mitigate going forward. At some point, I would say we will be exposed to that, but again because our products are value-added and we're really doing custom manufacturing, we're not really the ones taking the liabilities if the partners are. So we're not really at the higher end of that spectrum.
John Chu, Analyst
With the smaller lot sizes, your risk is lower as well, right?
Tyler Robson, CEO
Correct, yes. We basically mitigated as much risk as we can, selling smaller losses at smaller volumes, across different provinces rather than overburdening one province at a time. That’s why we've gone strategically into each province and have negotiated supply agreements with them directly.
John Chu, Analyst
Okay.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
Yes, to just add a little more color: on the 2.0 product side, we've seen fewer returns and more demand. Obviously, it's early innings. On our beverage front, initial shipments, we said we're sold out in Ontario. So, I think that’s an encouraging sign. For our branded partners coming online, especially with different companies facing bankruptcies and everything else, there’s a lot of market share up for grabs for them to define themselves, and it is our job to differentiate their brand and put their best foot forward into that provincial supply chain.
John Chu, Analyst
Okay. And then my second question is just in terms of... you talked earlier about expanding your footprint internationally as early as 2021. I'm just curious what you need to see from a market development perspective to warrant that move because we're seeing a lot of LPs make the jump a bit too early, and obviously they've had to scale back shortly thereafter. I'm just curious what you need to see in a specific market to want to make that move and then the required investment thereafter?
Jeff Fallows, President
Yes. Thanks, John. I will start with this one. The conversation we have starts with distribution. We know that we can put value in a box anywhere, and we know what's coming out of that box in a high-quality fashion. Therefore, we need to ensure we can sell and distribute the products in the new markets. Each market conversation begins with distribution, and we work back from there to assess the opportunity and right-sized facility. Thus, any international expansion we do will start small and grow in the context of the market. There won't be any big swings or large investments on an international perspective. It will be start low, go slow, and make sure that we can be a part of the product we want through the right distribution channel.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
From an internal standpoint, we look for near-term revenue opportunities and the payback period. We don't want to put an asset down and wait for the market to legalize. We want to ensure that revenue-first dynamic by finding distribution, then build it out accordingly to optimize that supply chain.
John Chu, Analyst
Okay. Great. Thank you.
Operator, Operator
Thank you. Our next question comes from line of Kimberly Hedlin with Canaccord. Please proceed with your question.
Kimberly Hedlin, Analyst
Okay. Thanks, guys, and good quarter. Most of my questions have been answered, but maybe could you comment if you’re seeing any weakness in your average tolling rate?
Jeff Fallows, President
Tyler, maybe we'll turn that to you.
Tyler Robson, CEO
Yes, at this point we're not seeing any weakness in tolling rates. Depending on the form factor of the product you're going for, each type of extraction has a very different payment structure, whether it's CO2, ethanol, or hydrocarbon. With hydrocarbon, we are actually seeing almost a fight for capacity because everyone wants to participate in that value-add service, and with our contracts, we actually created it at the escalating scale based on volumes, quantity, and duration of contract. We've built expectations on tolling already. The demand for capacity in hydrocarbons is far more significant than we ever thought.
Kimberly Hedlin, Analyst
Great. And then maybe just on the SG&A side, is Q1 a good run rate that we should be looking at for the year or do you expect that to ramp up because the new facilities come on?
Jeff Fallows, President
Chris Buysen, maybe we'll turn that one to you.
Chris Buysen, CFO
Yes, definitely. I can speak to that. I would say on the SG&A front, I think in the short term through Q2 and into early Q3, Q1 would be a good indicator of what our run rate will be. Obviously, as we transition and expand our footprint, we will see some increases as we bring that facility online in the latter half of the year.
Kimberly Hedlin, Analyst
Okay. Great. Thanks so much.
Operator, Operator
Thank you. Our next question comes from Robert with Stifel. Please go ahead with your question.
Unidentified Analyst, Analyst
Hey guys, thanks for taking my questions here, and congrats on that quarter. I just wanted to touch on the decrease in volume that you're seeing in that quarter and compare it to Q2 and whether that's attributable to COVID or perhaps just a more gradual rollout of 2.0 products. Obviously, we've seen reports of demand surging at retail for COVID-related reasons, but how is the rollout of 2.0 going in your view? Assuming a 10% to 15% share of market in the early months of this year, how do you see that progressing this year?
Jeff Fallows, President
So maybe I'll take a first shot at that and then we can pass that off. I'd say first off, it would be oversimplifying to say the slowdown was all related to the COVID crisis. Our partners and their inventories need to be considered in this context. There is a compounding factor. If I were them, I'd want to work through the inventory I have, given the current market, without expending additional working capital. There’s a dual effect going on there. From a cannabis 2.0 product perspective, we continue to think we've just scratched the surface on the demand for those products, particularly as new products are set to hit the market and new form factors. We have a lot of exciting things in our pipeline that haven't even reached the market yet, so we believe the growth of the cannabis 2.0 market will be substantial.
Everett Knight, Executive Vice President of Corporate Development and Capital Markets
And Rob, just to expand on what Jeff said, the smaller lot sizes for the different SKUs in 2.0 is why we welcomed moderation into this. In Q3, Q4, our expectations for the back half, from a volume standpoint will increase again. Thus, the moderation stopping now will yield an increase in demand and kilograms in the back half because more oil products are sold. We've also seen retail sales being $154.2 million in January, creating a $1.85 billion annualized industry. We haven't scratched the surface on 2.0 products, and we can see that grow. I think we have a significant opportunity for 2.0 products to become 50% of the market, or more – that’s our long-term outlook since consumers are more inclined toward convenient products.
Jeff Fallows, President
We are looking at the opportunity we have from a white label perspective. The current market gives us an opportunity to accelerate that program which is great. But on the base extraction side, we’re having conversations with our customers, both new and existing, and that focus on core operations. The extraction services we provide may not be core through a number of those parties. So as we look to the back half of the year, it's not to suggest that extraction services won't be in demand. They will be in demand, and we’ll be able to deliver those value-added services as our partners focus on their core operations.
Unidentified Analyst, Analyst
Okay. Great. Thanks for that color. A smaller question is with the evolution of the big shipping towards the white label category. Forgive me if it's a rookie question, but how do you see your procurement prices trending alongside that with obviously an excess of supply in the wholesale market currently?
Jeff Fallows, President
Tyler?
Tyler Robson, CEO
Yes. The excess supply in the market, when you really look at our platform, it’s convoluted. Depending on the product, we see the overall price per gram increase depending on the form factor going through the delivery system. A lot of people don’t understand the last part of the Canadian cannabis sector is that much of the product is inferior. There are low volumes of high-quality products that we use to essentially put into our hydrocarbon lines, which will still be sold at a premium. The overall market doesn't affect us so much concerning different types of extraction or form factors, but we will capitalize on low-grade product to bring into distillate or isolates, which I think a lot of people are currently underestimating the demand potential.
Unidentified Analyst, Analyst
Okay. Great. Thanks guys.
Operator, Operator
Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. I'll now turn the floor back over to Tyler Robson, CEO, for closing remarks.
Tyler Robson, CEO
Thank you, operator. To close, I want to reiterate a key differentiator that separates the Valens Company from its peers; our intellectual property. The investment our company made in IP in its early stages has already and will continue to both benefit our business and our customers as the cannabis 2.0 market evolves. Our cannabis-derived terpene database has set our customer base apart from others in the marketplace and is top-ranked among Provincial retailers. Our SoRSE by Valens Emulsion Technology, which aided in our ability to be the first to market in Ontario as beverages, allows consumers predictable experiences with zero cannabis taste, odor, or color, and a predictable onset and offset. Our proprietary technologies and advanced R&D capabilities allow us to bring high-quality, differentiated products to the market, and evidence shows that our existing and prospective customers are recognizing this demand increase through fiscal 2020. We only expect this demand to continue as we bring hydrocarbon products, including waxes, Shatter, live resins, and other concentrates to the market starting at the beginning of Q3. The third and fourth quarters of fiscal 2020 will allow us to showcase our capability as a leading cannabinoid-based product developer and manufacturer. We are just getting started here at the Valens Company. In closing, I would like to thank everyone on the call today for your ongoing support, allowing the Valens Company to grow as an innovator in the cannabis industry and serve our customers safely and efficiently. We wish safety to all listeners and their families. With that, I will ask the operator to close the line.
Operator, Operator
Thank you. This concludes our conference today. Thank you for your participation and have a wonderful day.