Thank you. Good afternoon and welcome to the KushCo Holdings first fiscal quarter 2019 financial results conference call.

A replay of this call will be archived on the Investor Relations section of the KushCo Holdings website ir.kushco.com. Before we begin, please let me remind you that during the course of this conference call, KushCo 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. These risks are outlined in the Risk Factors section of our SEC filings.

Any forward-looking statements should be considered in light of these factors. Please also note, as a Safe Harbor, any outlook we present is as of today and management does not undertake any obligation to revise any forward-looking statements in the future.

With me on the call today are Mr. Nick Kovacevich, KushCo Holdings' Chairman and Chief Executive Officer; and Mr.

Chris Tedford, KushCo’s, Chief Financial Officer. With that, I would now like to hand the call over to Nick.

Nick, please go ahead.

Thank you, Phil, and thank you everyone for joining our call, recapping our first quarter of fiscal 2019. We just did our last call little over a month ago.

So, we’re going to run through this one a little bit quicker, but wanted to touch on some of the highlights from Q1, talk about some of the strategic moves we’re making here at the Company, and also take a brief look at the future outlook and what’s coming down the horizon. So, first and foremost, I'd like to talk about our revenue growth.

We posted first quarter revenues of $25.3 million. This is a Company record.

It represents approximate increase year-over-year of a 186% compared to Q1 of last fiscal year and a consecutive Q4 to Q1 increase of 26.5%, and this is significant because historically there's not been much of a consecutive increase in Company history between Q4 and Q1 due to less selling days in the period and also due to some seasonality. So, we're very pleased to see this type of sequential growth going from Q4 to Q1 and starting off fiscal ‘19 in a really nice fashion, especially when it comes to revenue growth and pipeline.

We see the customer base getting more sticky with us, we see the cross-selling metrics going in the right direction. We're going to talk a little bit more about that when we get to the supplemental earnings slides here later in the script.

But we -- a lot of good trends and most importantly, we see new clients coming onboard onto the platform, existing clients growing with us, spending more dollars with us. And we attribute all this growth from Q4 to Q1 to 100% organic.

No acquisitions were made in Q1 that would add additional growth to this. So, we're pretty happy with the growth and we want to leverage Q1 into continued significant growth throughout the fiscal year.

And the next point I want to address is the margins. The Q1 margins were definitely lower than expected and we took time to break out a non-GAAP table to show some of the reasons as to why.

The biggest reason that stands out, if you refer to the non-GAAP table, we do an adjustment for non-recurring airfreight costs as $1.25 million that we spent in airfreight. We addressed this on the last call.

Obviously, we were in the middle of -- we had just finished Q1 when we did the call and we talked a lot about the air-freighting. This was strategic on our part.

We believe that this is still super early days. There's a huge market opportunity here obviously.

We're a first mover we, want to grab market share, and not at all cost but we do want to do, make significant investments in grabbing that market share. Air-freighting in our opinion was an investment that we needed to make.

How we boat shipped these items in, had we been prepared from a supply chain standpoint for the demand which was virtually impossible to do, we would have saved $1.25 million. Now, that's the bad news.

The good news is we've gotten ahead of this. I mentioned on the last call, we fixed our factory partner.

We have the right factory partner that can produce a significant amount of quantity and get ahead of this. Our cost, it was also significantly reduced with the new partner, almost cut in half, believe it or not.

So, a lot of good trends, but ultimately we won't see throughput on those until about Q3. Q2, which we're in right now, we've officially stopped all the air-freighting but obviously we have some of Q2 where there is air-freighting and we also have product costs on some of these items that are going to be higher than normal.

And we look at that normalizing somewhat in Q3 and certainly by Q4 and tracking toward our goal of getting into a profitable fiscal 2020. So, normalizing airfreight, normalizing temp labor, also talked on the last call that with the spike in demand and these few SKUs, we had quality control issues that prompted us to hire temp labor here stateside and be able to pick some of those quality issues, washing jars, things like that, clean them.

With our new factory partners, they’re producing clean room facility this extra cost is going to be eliminated. Again, we won't see throughput until Q3 and Q4, but this is another thing that we wanted to identify as something that's bringing down the margins here for Q1.

We also noticed that the mix shift was a driver for margin decrease. We typically have been around 50% in vape.

We talk a lot about how vape is one of our lowest -- is our lowest margin category bucket. And we saw the mix shift rise in Q1 from 53% where it was in Q4 to 60% of sales in Q1 ‘19 coming from the vape category.

We also saw a surge in disposable vape sales which is our lowest item within the category. And so, we're working on improving our cost structure and our pricing on these disposable items.

It wasn't a huge part of our portfolio before due to this recent spike and seeing how it's impacted our margin and cash flow. We're also going to be evaluating different scenarios around the tariffs.

The tariffs -- we filed exclusions against the tariffs because these vape products are solely produced in China and not available in the U.S. We're optimistic that the exclusions will be approved.

However, as this -- tariffs drag on, we are evaluating other options, like passing more costs to the customer. We are making strategic investment and eating these costs because we wanted to grab market share and we believed that the tariffs were going to be temporary and the administration was going to work through them.

And so, as they continue to progress, we're evaluating other strategies to be able to pass some of these costs on and be able to reduce costs on these items so that we can improve margin in the vape category. And if that is over 50% of our sales, obviously that's a big drag on our overall margin.

The mix shift will improve. We have a robust plan to improve it.

And we talked at length on the last call, and we'll touch on it again when we get to the supplemental slides. But, it's going to take some time, and I'll explain more on that later.

So with that, I want to address the plan that we discussed on our last call to get our margins back over 30%. We're very confident in that plan.

Obviously the moves that we're making around the vape category, mix shift, and the operational efficiencies are going to play a big part in that. We're also doing a lot of things with our other supply partners as well.

Our factories, our glass factories as I mentioned, costs have come down, quality has gone up, production capacity has gone up, that will eliminate a lot of the unnecessary freight. The washing of the jars, the cleaning of the jars, some of this aftermarket quality control, we're not going to have an impact on that come Q3, Q4.

Most of that is being eliminated as of this month. And again, there’s still going to be items that have throughput sales that have higher cost to them associated with this, but it's going to improve here pretty quickly.

And we're going to be able to continue to cross sell effectively. We have a great data coming to show the trends that we're making there.

And again, we expect all this to culminate and see meaningful improvement in Q4 and certainly in fiscal ‘20. So, let's talk about some of the strategic moves that we're making.

We are making investments in our operations. We announced on our last call the implementation of Manhattan, WMS, Warehouse Management System.

We expect the implementation to be complete during this Q2. We’ll see throughput in our financials in Q3, but we won't have that system rolled out companywide until the end of fiscal ‘19.

So, the full impact will be through in our fiscal ‘20. We're also -- been making significant investments in personnel.

We're reducing some of our lower level labor through eliminating some of the temp labor and also through the system efficiencies that we’ll gain from the WMS system. And we've hired all of our senior team virtually.

So, all of our senior leadership team and vice presidents are all in place. This is again an investment that we've made to be able to onboard these folks ahead of the growth that we're expecting and be able to leverage our current team to exponential revenue growth.

And we believe that now that most of that team is in place, it should only improve ratio going forward. We're also working hard to optimize across our warehouses.

Right now, we're not always shipping from the appropriate warehouses. To give you an example, our Massachusetts facility that we put up in June, we are now seeing more throughput out of that facility due to the wrack market in Massachusetts opening up.

However, if you look at our data, only half of our orders are actually being shipped from that facility. And one of the main reasons why is we just haven't had the inventory, the supply hasn't been there, and that's been drastically improved.

And we should expect to be able to stock that warehouse appropriately, either in Q2 or certainly by Q3. And we'll see the optimization throughput improve, both our margin and our operating expense.

So, that's one example. But we have to do that across the board.

We have to get better, we have to get more optimized, we have to be able to ship from the appropriate locations. We're also looking at expanding our service capability.

Right now, we're doing a lot of our labeling application and printing services out of the California warehouse. Now that we've got that dialed in, we expect to expand that out to our additional hubs and that should make that business more efficient and more profitable.

We also have plans to eliminate things like free shipping that we've offered across the board. And we're seeing that that strategically has paid off.

We've garnered a lot of market share. We’ve brought in a lot of new customers, but that value is not as important to some of the bigger dollar customers that we're now dealing with.

And we may eliminate that which again will make us -- will improve our operational expenses. And we're looking at growing into our warehouses.

Some of these warehouses we put up, like Massachusetts again for example, much bigger space than we currently need today. But as those markets grow, we expect to grow into them.

And Massachusetts, for example, the quarterly revenue that -- and we do break it out in the supplemental earnings slides, we'll talk a little bit about that and the trajectory that that's going. But as we see that revenue growing, know that we will now be growing into our facility and becoming -- better optimize on our cost structure with our Massachusetts program.

So, the next piece I’d like to discuss is our strategy around customers. Really, it's a gain, retain and grow strategy.

And that strategy is working extremely well. We're developing very strong relationships, especially in our national accounts division, which only focuses on multi-state operators and Canadian LPs.

That division has garnered a lot of new relationships. Those relationships are now seeing throughput.

And we're in the process of -- now that we've on-boarded them into the Kush Supply Co. platform, seeing cross-selling throughput where they're moving in and buying product from us across different categories.

This is especially key for new markets. We're now seeing in these limited license markets that a lot of the licenses that are given new licenses are existing multi-state operators, which works out great for us, if we already have a relationship with them.

Now, we can easily leverage that relationship to get new market opportunity growth. A great example is New Jersey.

New Jersey just gave out six additional licenses. We looked at the list of the six licenses, and we are already working in some capacity with five out of six operators.

So, we know that our market attack from New Jersey is going to be pretty simple. We're going to leverage those existing relationships and we're going to make sure we get their business day one when they get operational.

So, the relationships are key, can't stress that enough; market share is key, can't stress that enough either. It's still really early stage.

We use the expression that we're still in the second inning. And at this early stage, garnering those relationships, building brand loyalty, getting customers sticky within the platform, this is all much more important than some of this other stuff that we're also going to fix along the way.

But, you can't build a profitable business if you don't have the market share and the revenue coming in. We've done a really good job of establishing ourselves and grabbing that market share.

And now, we need to continue to make improvements to turn that revenue into profitable revenue. And again, we have a plan and a goal to do that and create a profitable fiscal 2020.

So, it's typically easy to onboard these clients into single product category. What does take time is then selling them across the platform.

So, now, I'll refer to some of the supplemental earning sites. So, number one, let's look at the cross-sell progression.

So, if you look at the customers that we now have put into these different buckets, last fiscal year, we only had a bucket of 500,000 plus; we've added a revenue bucket of 1 million plus. And we've broken out that last year in fiscal ‘18,there were four customers that spent over a $1 million.

As of the end of Q1 on an LTM basis, that customer book has nearly doubled. There are seven customers that have spent over $1 million with us in the last 12 months.

And the trends are all going in the right direction. There's more customers that are spending the 500,000 to 1 million bucket, more customers in the 250,000 to 500,000 bucket, more customers in the 100,000 to 250,000 bucket and so on and so forth.

And we also see above the average SKUs purchase increases as folks move up into these buckets. Obviously, on the low end, 13 SKUs, still a decent number of SKUs, but that's where we see the customers spending 10 to 50 grand spend, buying is drastically different to the top end of the chart where customers over 500,000 are spending -- are buying on average 56 SKUs from us; customers over 1 million are buying 45 SKUs from us; and these larger customers, part of the progression is cross-selling them into more SKUs, it doesn't happen overnight.

But I can tell you, the process is underway and the data is showing that it's working. So, we're going to be doubling down and tripling down on that strategy as we believe it's not only good for building a sticky relationship with that customer, it’s not only good for optimizing and enhancing our margins, but it’s also something that makes our business more defensible long term.

And we’re ultimately building defensibilities and modes for what we believe is going to be the future competition. They’re not here to feed in today because of a lot of the challenges around this industry, but they’re going to come at some point.

And so, what we focus on a lot here at the Company is how do we defend against that, and it’s a multipronged strategy, but cross-selling, building sticky relationships and getting customers to buy across the platform is a big component of that. I’ll turn now to the revenue breakout by state, a lot of exciting things to discuss here.

Number one, California continues to grow significantly. In Q1 2019, we had revenue of almost $14 million in California.

That was up 211% year-over-year and it was up 45% Q4 to Q1. We’re still seeing California struggle with black market.

We know that that’s getting addressed by the Bureau of Cannabis control and other regulatory body. But we expect the effects of that only to be positive for our revenue growth in California.

And so, even though California represents a big portion of revenue, we think that the upside is still much bigger than the current state of affairs here in California. Another thing to call out is the revenue in the Northeast.

Massachusetts, as I mentioned, is now growing and we’re hoping to grow into that footprint that we’ve already established up there. In Q1, in Massachusetts, we did over 400,000 in revenue.

This is up 68% compared to Q4; we only did 250,000 revenue. As we sit here almost halfway through Q2 of fiscal ‘19, we’ve almost surpassed our Q1 number of 413,000 in Massachusetts, meaning we’re on pace to double again in Q2.

And my prediction is that we’ll be able to double Massachusetts every quarter this fiscal year. So, we’re talking about exponential growth in Massachusetts due to the wrack market coming online there; and the Northeast as a whole as a percentage of our revenue is still only around 3%.

We expect that’s going to balance out and Northeast led by Massachusetts is going to become a much -- a bigger weighted percentage of our overall sales. We also have broken out Michigan here for the first time, because the Michigan market voted in wrack legalization last November.

And we expect big throughput for Michigan; we’re seeing it now already, even though it’s still medical-only. As folks are positioning to become leaders in that market, there’s a migration for quality; and as folks are getting more scale, they’re migrating toward a larger suppliers like us that can support them as they grow.

So, we’re going to expect meaningful increases in Michigan. And then of course, Canada, the market dipped a little bit for us between Q4 and Q1.

That was because of the shortage in Canada. Most people stocked up significantly before the October 17th launch date.

But we’re still up over 800% year-over-year Q1 ‘18 to Q1 ‘19. We expect Canada to continue to grow significantly.

I recently spent some time up there meeting with some of the LPs. There’s a lot of opportunity in Canada, but also a lot of opportunity globally through those LPs.

And we’ve established relationships with several of the leading LPs and we expect to leverage those into continued Canadian sales and continued international sales. So, overall, we’re very pleased with the revenue by geography and we’re seeing growth in all of our key regions.

Some of the regions were a little bit flat and that was expected, especially because as I mentioned, there’s typically not an extreme amount of growth for our Company between Q4 and Q1, but we’ll continue to monitor these as the fiscal year progresses. And I think we’re really going to like the way that the data shakes out.

So, let’s talk a little bit about some of the other initiatives that we’re working on here. The initiative to improve the mix shift, number one.

And I’ll refer to the supplemental earning slides, revenue by five categories. We see in the breakdown that labels, seals and applications were 2% of our revenue.

But that’s growing significantly, up 160% year-over-year, which is why we decided to make this its own category, because we see a lot of upside in it. So, up 66% from Q4 to Q1.

We also see packaging at 20% of revenue. This is actually down as a percentage because vape was up so high as a percentage, and there's a story behind that and it has to do with the inventory shortages.

So air-freighting and inventory not being able to get enough, a lot of that was on the packaging side, and as a result it suffered. But we have a ton of opportunity coming out with packaging.

We have some supply agreements that we're working on that are going to be huge. Koleto, which is our innovation arm is launching new packaging products that are expected to be big sellers.

And we have custom projects that we've been working on with specific large clients coming to completion here in the near future. And Koleto has filed over a dozen -- almost a dozen patents so far, and there's a whole pipeline of patents still yet to be filed for Koleto.

So, that division is very focused on innovating around packaging and that innovation is going to lead to more growth in this category. Now, we're overall pretty pleased with the percentage of packaging although we expect it to grow as an overall percentage in future quarters.

Vape was 60% in Q1, as I mentioned. We'd like to get this back down to 50% or below.

We believe that we can. But here's sort of the challenge around that.

Our average vape product sells for $2.25 whereas our average packaging product sells for about $0.50 to $0.75. Our label is around $0.02 to $0.04.

If you add application, you can get in the $0.12 to $0.15 range. Energy and natural products to produce 1 gram of oil, you're probably looking at using somewhere between $0.10 to $0.15 of butane or ethanol; you're probably looking at using somewhere between $0.15 to $0.20 of natural product.

And then papers and supplies, a paper cone for a pre-rolled joint, you're going to be somewhere around $0.12 or $0.13. Supply is probably a few cents per unit.

So, as you can see, in order to effectively cross sell and balance this out, it's not as simple as selling somebody vape and then adding a packaging item or selling them vape and adding a paper supply item. We actually have to sell across the whole platform.

And we think we can do that. Obviously, the data is showing that the cross-sell trajectory is going in the right direction, but it's going to take some time.

So, we need a little bit of time to balance this out, and we have the strategy to do it. But, if we can sell across all five categories and do it effectively, we're going to be able to leverage out of vape as a majority percentage and get it down under 50% and we expect to be able to do that earliest Q4 but certainly by fiscal ‘20.

So, looking back into buckets. Energy and natural products grew from 8% in Q4 to 9%.

We have Q1 -- the Q1 growth was astronomical because we didn't have this division until May of 2018. But we see tremendous upside in the energy category.

We know that extraction from butane and ethanol is definitely taking a lot of market share away from CO2 extraction, plays right into our hands. The one -- the challenges that we have had however, is that California has been a little bit slower to give out butane licenses; they've been giving out more ethanol licenses.

And as a result, we've been investing more heavily in our ethanol infrastructure to be able to support these ethanol producers. We expect butane licenses to balance out over time, which is going to take a little bit longer.

We're certainly the market leader for butane sales and we hope to become the market leader for ethanol sales as we continue to improve our supply chain. We're also now going the extra mile to do validation around the licenses.

We think it's really important, especially as California battles the black market that we set the tone and only work with licensed operators. And it's so important that we're actually in most cases validating the license and at least ensuring that the client is going through the licensing process before we'll even sell them product.

So, this creates an extra operational step which slows down the revenue growth a little bit in this category but it's the right thing to do and it's going to set us up for future bigger success with this category. We also announced and launched a prototype of our stainless steel tank last year in Las Vegas.

This tank is going to be much more efficient for this industry. We expect to see significant throughput in terms of volume of sales and also price points, once we get this tank launched.

The actual rollout is planned to be in Q4 of this fiscal year. But the prototype did get a lot of attention at the recent trade show.

Another call out for this category is the natural product sales. We basically on boarded our new partner and sort of relaunched this category for us back in October.

Since then, the sales have already quadrupled on a monthly run rate basis, starting with a small number, but seeing huge potential upside here. Natural products category is growing as overall trend.

We're seeing more people put an emphasis on this category. And we're really well-positioned with our distribution infrastructure and with our partnership that's in place.

And we expect this category to improve in terms of the overall growth but also this category today has a decent margin and we have some improvement coming in the margin profile as well. So, as this energy and natural products category continues to grow and become a bigger portion of our overall revenue, it will really pay off in the overall margin enhancement of our total business.

And then we -- the next thing I want to talk about is -- after looking at the supplemental slides is really the future outlook, talk a little bit about the markets. Obviously, the Northeast huge potential; Canada has a huge potential coming down the horizon; Michigan, there's a lot of activity in the northeast with states like New Jersey and New York, talking about legalizing Illinois, talking about legalizing all of that stuff is going to be a couple years out from translating to revenue but a lot of exciting things happening.

And again, California is still continuing to grow significantly. California is our home base.

We love everything that's happening in the market here other than the black market, still lingering around. And we're going to take advantage of our insider knowledge, our relationships in this market to continue to leverage significant growth.

Another huge opportunity that presented itself recently is the signing of the Farm Bill. The Farm Bill essentially legalizes CBD.

We've now seen several of our clients who weren't in CBD announce that they're now going into CBD. A lot of our clients that are currently in CBD, they're expecting significant growth and we're preparing for that with them.

The growth for us in CBD is going to come around packaging of course. Vaping as people are liking to vape CBD and that's been happening and is going to only continue to grow.

Also with the energy and natural products category, there's obviously flavoring of that CBD oil, but there's also ethanol extraction of CBD. And we're in the process of negotiating some big ethanol deals with some of the top CBD extractors.

So, we expect that to be a huge boom to the business that was not around prior to the Farm Bill excitement. And then also on the branding side, as more folks move into CBD, they're going to need to launch brands.

And obviously, we have a full spectrum creative agency, Hybrid Creative, that will be able to take advantage of that trend and be able to help some of these players launch into the CBD space with their branding and marketing. Last thing I want to talk about is the M&A strategy.

As I highlighted earlier, what's really exciting for us is that all of our growth from Q4 to Q1 was organic. Our growth pipeline is all based around organic growth.

Our estimates that we've given out, our guidance, assumes nothing but organic growth. And so, we're really an organic growth story.

We see so much upside in organic growth that we've turned our attention away from M&A. However, we still continue to look at deal flow.

There's some smaller M&A opportunities that we're evaluating that we may consider bringing on board but nothing major on the M&A front as again the organic growth front is so exciting and it's such an open opportunity for us to continue executing doubling down on our strategy, gain more market share, being a first mover in new markets and opening up our product categories and becoming a very robust sales and distribution platform for this emerging industry. So, with that, I'd like to turn the call over to Mr.

Chris Tedford, and introduce him to everybody, we did briefly last call. But Chris will go through some of the financial highlights of the quarter.

Go ahead, Chris.

Thank you. Relatively short time that I've had the pleasure of being part of the KushCo management team, it’s clear the Company is progressing rapidly in the right direction.

KushCo’s strong Board oversight and support continues to invest in top talent at all levels in the organization. As Nick mentioned, we're very focused on investing in value added operational improvement opportunities such as our new WMS platform.

In addition to new systems, we are also acutely focused on ensuring that we have the right processes in place to fully optimize our technology investments and maximize all available operational efficiencies. Truly an exceptional opportunity to be part of a company that is so well-positioned to capitalize on the rapid growth of the cannabis and CBD sectors.

Now, turning to our first fiscal quarter 2019 financial results. Total net revenue increased 186% to $25.3 million in the first fiscal quarter of 2019 from $8.8 million in the first fiscal quarter of 2018.

Increase in revenue is primarily due to the significant overall growth across all markets and product categories, as Nick highlighted. On a GAAP basis, gross profits increased to $3.2 million in the first quarter of 2019, up from $3.0 million in the first quarter of 2018, as a result of the overall growth in sales.

Gross margins as a percentage of net revenue were approximately 13% in the first quarter of 2019, as compared to 35% in the same period a year ago. This recent margin compression reflects the higher cost we have incurred in terms of airfreight, direct labor and other inefficiencies associated with our evolving supply chain.

As Nick mentioned, we have several strategic ongoing initiatives addressing these trends and we expect to see continuous improvement going forward. This impact is likely to be realized in our financial results commencing in the back half of 2019.

On a non-GAAP basis, excluding the impact of short-term supply chain capacity issues and recent non-recurring vendor quality control initiatives, adjusted gross margins were approximately 20%. Operating expenses in the first quarter of fiscal ‘19 were approximately $11.3 million compared to approximately $2.9 million in the first quarter of 2018, primarily due to an increase in the salaries and benefits expense, facilities costs, and professional fees.

The increase in SG&A as a percentage of net sales reflects the Company's strategic investment in building its platform to enable the Company to effectively scale and support continued long-term revenue growth. On a GAAP basis, net loss for the first quarter was $8.2 million or negative $0.10 per share, as compared to net income of approximately $0.1 million or zero cents per share in the first quarter of 2018.

On a non-GAAP basis, excluding the impact of the non-recurring charges described previously as well as other non-cash gains and losses. Our net loss for the quarter was approximately $8 million or negative $0.10.

As of November 30, 2018, we had cash of approximately $3 million compared to approximately $13.5 million as of August 31, 2018. I'd like to highlight that the Company has made a significant investment in purchase of inventory ahead of Chinese New Year.

We believe this is a critical initiative to ensure we meet customer demand, especially with respect to customized product which typically has longer lead times than other stock products. As I continue to familiarize myself with the cannabis sector, I've come to understand historically that securing financing relationships has generally been a unique challenge in the space.

Fortunately, as new legislation continues to get passed and more and more states continue to legalize cannabis for medical and adult use, we are seeing the credit markets continue to open up as many financial institutions are becoming more and more receptive to our business. We believe this will present us with additional opportunities to better leverage our current asset base to help us manage our significant working capital demands.

With that, I'll now turn the call back to the operator for the Q&A session.

Thank you. Good afternoon.

Good afternoon, Vivien.

So, I really appreciate the candor and the transparency around the margin challenges you guys faced in the quarter. Presumably some of the potential remedies that you’ve mentioned or your discussed with your clients or customers, namely the potential for raising prices in particular in the vapor.

So, one, I would love to hear any kind of incremental color on how those conversations are going? Number two, what your expectation is for any kind of consumer attrition on a price increase?

And more broadly, number three, how you’re thinking about price elasticity is for those products? Thanks.

Thanks, Vivien. And things are moving so fast, as you can imagine with the growth that we’re experiencing and with the dynamics in the industry.

And so, sometimes it takes looking at the data that to reflect and figure out strategies. And we’ve certainly started in motion on having this some of those conversations and digging around and seeing where the opportunities are.

And the reality is that the vape category is moving so fast, the volumes are picking up and we’re aligned with the premier supplier, see sale, and there’s really more demand than there is supply. So, the reality is some customers will down trade, obviously.

But the bigger players, they need to be on the platform. This is the best quality product in the market.

It’s the only product that’s proven at scale. And so, right now, these -- a lot of these folks that we work with are in a similar situation like us.

They’re going after market share and they’re trying to build the brand. And so, for them to down trade quality at this point and risk not being able to build the quality consumer brand, it would be a bad move.

And so, certainly, price increases are never well received. But this is more around the tariffs that we’re facing and sort of a pass-through there.

But we’re also working with the manufacturer on the other side to be able to get the cost down, so that the price increase, if any, is minimal. So, we’re not too concerned about attrition, especially because when you look at the stickiness of our platform.

That’s why the average SKU sold is so important to us. Because we feel that if we’re selling somebody 56 SKUs for example, and there needs to be an incremental increase in 2 or 3 of those SKUs, that’s -- for them operationally to sort of change everything and go on-board, a new vendor to service those 2 or 3 SKUs is going to be not worth just paying the extra added increase.

So, we’re still evaluating. We need to get smarter about how we price our products.

And certainly we’re going to be customer centric, customer first, because it’s part of our DNA. But we know that, we’ve been bending over backwards in a lot of instances, stuff like tariffs.

I mean, it’s out of our control, right? It’s not our responsibility.

So, some of those costs will get passed through. We don’t think that this is going to create any meaningful attrition or anything like that.

And ultimately we have really good relationships, so we can be upfront and honest with our customers about this. And I think it’ll be fairly well received.

Terrific. Well, that makes perfect sense, [indiscernible] the first company under my broader coverage, that’s a long tariff related price increases to offset your commodity inflation.

So yes, that makes sense; that is how business works. So, thinking about your vapor mix, was there anything nuance in terms of shipping to geographic jurisdictions that you’re kind of the inventory tilling now, i.e.

was there any kind of geographic distortion driven by like a Canada or Massachusetts where that vapor mix might normalize over the course of the year?

Could you repeat? I don’t understand -- fully understand the question.

Sorry.

Sure. Was your vapor -- the increase in your vapor mix is driven by outsized vapor shipments into markets like Massachusetts or Canada, or is vapor taking share across the whole country?

Yes. I mean, I think ultimately vapor is taking share across the country.

We saw the California data. Vivien, you’re way more into the data than me.

But, I think ultimately the other states are starting to follow that right. The California data showed vape over a third of the market.

So, I think that’s macro trend. Obviously, Canada -- know based on the THC side, some folks doing CBD vape a little bit now, especially the Farm Bill coming to the U.S., some of these folks on the vape front.

But, it’s really more about they being an easier sale. That’s the other kind of going back to your point of your first question is, why people are going to continue to pay for these vape products.

I mean, they are the best; they’re premium in their quality and so it’s pretty easy to sell. So, our sales people tend to lead with that.

So, there’s things we can do on the compensation side to hopefully incentivize again our sales people to lead with other stuff. Like, what we see is when we get a huge rush of new customers, it's typically getting them into the platform through vape.

Now, that's not necessarily a bad thing because once we get them in, we can then sell them across. But in terms of the impact in a single quarter's revenue, this is what can happen, right, the vape mix can ramp up significantly, 6 or 7 points, like we just saw here in Q1.

So, overall, I think it's a little bit of the market, it’s also just a little bit a function of sales velocity and the quality of these products and being able to sell them very quickly into new customers. And like I said, one of the biggest drivers was we on-boarded some new customers that came in on the disposable, which we have the lowest margin of all the vape products.

And obviously the hope is once we get their disposable business, we can then get their cartridge business, we can hopefully get their pod business, and we can their packaging business or labeling business, so on and so forth. So, I think it's all part of the strategy.

But, we have to be mindful just because it can move very quickly, given the dollar amounts of the average vape unit costs and given the velocity of sell-through on these units.

Thanks. That’s very helpful and that definitely make sense.

My last question is on California, Nick, perhaps modeling was just off. But your growth in California was certainly more than we expected for you guys, which is really admirable considering some of the press reports that we're hearing about California as broader industry, actually we’re seeing expectations in terms of category development.

So, I'm just curious, just close to kind of the regulatory landscape in California. Could you comment at all on how you address the very specific [ph] the market that you called out on the call?

Thanks.

Yes. It's a great question and certainly is a thorn in the side of a lot of our customers as they're trying to compete against folks that don't pay taxes and have lower overall operational expenses.

So, they're dealing with that. We saw increased throughput especially in vape because a lot of these folks that were operating in the gray market were a little bit slower to get into the legal market and when they did they decided that they needed to go with a more premium vape solution which is why we saw the tailwinds behind that category.

So, a lot of it’s -- new people coming in and that may not be necessarily reflected in the historical data that you're looking at. So, I think the market is improving but the black market continues to exist.

I mean there's well over a 1,000 illegal dispensaries, which is over double the amount of legal dispensaries that exist in the state. We've seen Lori Ajax giving some consistent commentary around educating consumers to go the legal route versus the illegal route.

I don't think they can really effectively do that until they license more dispensaries. If there's -- if somebody has to choose between a legal store and an illegal store that are across the street from each other, I can see a consumer making the decision to go the legal route because the products are better brand names and they’re higher quality tested.

However, if that consumer has to drive 20 or 30 or 40 minutes, which is the case in a lot of these cities, they're going to simply elect to go with the illegal option which is closer and cheaper and there's not -- Lori thinks there needs to be more education around health effects and making sure you're going through something that’s been tested. But, I don't think that that alone is going to solve the problem.

So, I know they're working on multiple strategies, they're putting pressure on the landlords that are leasing to the illegal dispensaries. They're cutting off water and power.

We've seen that in select cities but it sounds like that's going to be a more broad approach that they're going to take here in California. And that has been pretty effective, although it's amazing, the workaround these folks would find to be able to do it but you know when you're able to make $20,000 or $30,000 cash a month, you'll go through some workaround I guess.

So, my main point and I’ve always said is I think you just need to license more folks. The best way to combat the illegal market is with an army of legal operators.

And I know folks like to have their limited license markets and that's great. But I think some balance there makes a lot of sense.

So, we'll see how it plays out, but I know more licenses are expected to come out. I know more crackdowns and different strategies around that are also in the works.

And I think overall, we're just seeing more investment in the space. Folks that who are now getting license, they’re not necessarily doing it because there's a huge opportunity to make money.

They're more focused on the long-term, building their brand, doing establishing the legal playing field and then being able to expand to multiple states. And that's where we come in and we are able to take advantage of those growth strategies that are underway by our clients.

Very helpful. Congrats on traffic top line this quarter.

Thank you.

Thank you.

Hey, Nick. Thanks for taking my question.

Across your product suites, what -- where do you have -- maybe you can -- can you force rank maybe your top two or three products we have the most pricing power? And your product inventory visibility, talk about how it's improved and what are you are specifically doing from the technology or customer standpoint to better manage the growth?

Yes. So, I mean, I think our packaging products, we've traditionally been more of a -- I won’t say necessarily commodities but certainly by more generic offer of products, which is why we decided to invest in Koleto and building our proprietary products.

And we expect -- we have a few products in the market today where we have some IP and they are unique and we expect that to exponentially improve. And those products can maintain much higher pricing power.

So, we're really excited about that. Anything with IP, anything innovative, one of the reasons that we're doing the stainless-steel tank is because we know the market will pay a premium for that.

It's a cleaner gas that is available in that tank. I mean, it's a more efficient vehicle.

So, we're going to look to leverage innovation, look to leverage IP to be able to maintain pricing power. It's also supply and demand, right?

I think we did a great job of getting onto the C-sell [ph] platform and being able to make that the market leader. C-sell in the legal market we estimate to be around 50% share.

A lot of that was due to us driving it during the last year and the other distributors C-sell. But it's become a point where the production is almost tapped out.

There's some actors making improvements that are coming online here in coming months. But anytime you see demand ramp that quickly, it catches up to supply, at that point you start to look at pricing.

So, vape, like we talked about, there's -- we're looking at that now. But we're seeing that in other categories, vapor cones for example, something that again our revenue has been held back simply because we haven't been able to get supply.

We made an investment in a joint venture to be able to receive -- plan to receive 36 million cones a month here by calendar Q2. And assuming we're able to get the supply, there's more demand for those products than there is supply and we should be able to charge a fair price point that reflects that.

So, I think, if I had to call out specific products, it would be the packaging products in which we have IP and also in the paper cones. And then from a supply chain standpoint, we're improving drastically how we deal and how we manage with our vendors.

Keep in mind, two years ago, we were basically a small company. When you look at the amount of skews that we sold compared to our revenue, we didn't have scale on any of these items.

Fast forward to today where we’re the market leader in virtually all of these categories, we’re becoming the biggest customer for a lot of these vendors. And we can now change that script a little bit.

Whereas before, we were doing things like prepaying, we were working to get better credit terms, more product flexibility where we were paying for all their shipping. We’re now looking to split costs when those air shipping fees arise.

So, there's a lot of things we can do to improve our supply chain. The WMS system will help from an efficiency standpoint with the technology that we're leveraging.

We're working hard to optimize our warehouse and have the right inventory mix in the right geographic locations. And all this stuff just takes time, because again the markets open up so quick and we just scrambled to try to fulfill demand.

And then as we get ahead on certain items or as we get ahead in certain regions, then we look to circle back and optimize in multiple places and that strategy is underway, and we feel confident we'll see meaningful throughput. And as Chris mentioned in the back half of this fiscal year, and certainly track toward our goal of being profitable in fiscal ‘20.

Okay. Thanks for the detail.

And a high level, what is the biggest driver of your business? One, either the ever state-by-state compliance nuances or the need to establish and grow a brand?

A focused question than I read there, Paul. They're both great.

And I think it's important to bring that up because there's a lot of nuances around the compliance regulations and we spent a lot of time. I mean our legal department recently doubled from one lawyer to two.

And we expect to continue to invest there because it's so important. We have to be ahead of the curve on these regulations.

We're working with a lot of these states to craft them and to be able to come up with different requirements that we think are there, because they protect public safety but they also create a free market. And our products plug right into that.

If they're different in each state, it provides a significant barrier for somebody who's outside of the industry that doesn't have that knowledge that we do. They don't have the ability to create a product portfolio that we do, because they just don't know what products are required from a compliance standpoint in each market.

So that's a huge advantage. And it's really what's built our advantage against traditional packaging companies.

Traditional packaging companies, they all see the growth in this space. They all want to come in.

We've started to bump up against some of them. They have not been very effective.

And the main reason why is because they don't have that deep understanding of the compliance and how it differs in each state and each market. On the other point that you made about the branding, that's what's driving the ASP up on our packaging category.

It is very competitive. As you know Paul, it's -- people are fighting for shelf space.

They're trying to build their brand. They're trying to scale their business.

And what that means is that they need to invest in packaging, they need to invest in the branding on that packaging. We know that, which is why we started offering customized branded packaging 3.5, four years ago while we created Koleto which is a custom packaging design division.

And while we bought The Hybrid Creative which is a full spectrum branding agency. So all those factors are extremely important as well.

I mean if I had to pick, I would say the state-by-state compliance but branding is right behind that and thanks for allowing me to share a little bit more color on that.

Great. Thanks for the detail.

Last question. Sounds like you have a very robust plan in terms of how to improve margins.

Maybe you can just give us the lowest hanging fruit option you have to grow margins higher. And maybe just a general timeframe on when you expect to get to 30%?

Yes. Well, as I called out on the non-GAAP table, right, that the non-recurring airfreight cost of $1.2 million, the non-recurring temporary direct labor cost of a $466,000, those two items alone improve our margin 7%.

So that's really the lowest hanging fruit. And I think ultimately by now we'd be negotiating again better pricing with our vendors.

A year ago, two years ago, we didn't have the leverage that we do have today. So some of the stuff you're just drinking from a firehose, you're trying to grab as much market share as possible and you have to take a step back and reflect and say okay now where are the opportunities and areas I can improve?

And I think negotiating better with our factory partners is going to be one of the lowest hanging fruit areas. But certainly getting out of our own way and getting ahead on the supply chain and not incurring these additional air freighting costs and temp labor that's something that that can happen immediately.

As I mentioned we've stopped air shipping as of now on our glass jars which was the main driver of that. Again we won't see the full throughput till Q4 but that's something that we've already gone ahead and done.

And it takes some time to get the new factory spot out, get the new molds made, get into production. But the nice thing is as we've gotten the volume, each new factory that we've on-boarded that we've also seen decreased cost.

So we'll be getting decreased costs just as the nature of the scale that we've gotten to. And so I'd say that's another point.

That's the low hanging fruit item that will drive cost down and improve margin

Hey, guys. I know that the call is running kind of long.

So I'll try to be quick. Congratulations on the strong revenue.

Okay. So for California, there's some new testing requirements this year for heavy metals and wondering kind of what the impact might be and the vape category, if any, with disruptions will help guys out or is this not material for you?

That’s actually a great question. It’s a category 3 testing that went into effect January 1, 2019.

They are testing for the heavy metals and they’re first I think to do that inside the physical cartridge itself. And unfortunately I’ve learned a lot more about science than I wanted to in the recent months as we’ve been evaluating this.

Ultimately depending on how that oil was made, what the terpene profile is, the PH level, how long the oil sits in the cartridge, the temperature of the cartridge throughout that period. All of that can actually have -- it can reflect different results when it comes to this cat 3 testing.

What we’ve seen across the board and we’ve done an in-depth analysis is that the products that we sell, the c-sell products are performing pretty well. There’s very few instances where they’re tripping the -- any of the requirements on the cat 3 status and for clients that have tripped, we’ve been able to bring in some partners that we work with people to address those issues, fix some of the processes behind them and get our customers compliant so that they’re able to pass.

On the flip side, there’s a lot of other products in the market and we’ll call them out specifically that are not passing at all, their way off. And so ultimately this is going to lead to more demand in my opinion for the c-sell products.

And again, this also goes into our strategy around why we’re going to be a little bit more mindful of how these products are priced and what type of class we’re eating along the way, because again cat 3 testing is going to be a requirement to be in the market. And if you can’t check that basic blocks, then you can’t make a single sale.

And ultimately if there’s enough value and demand, we should be able to charge appropriate for that. We want to treat our customers fair.

We want to be customer centric, but there’s definitely opportunity and I’m glad you brought that up. It’s an ongoing thing and we’re working and build process with testing labs with the regulators themselves and also with our customers to make sure it’s addressed.

Okay, great. So it sounds like a positive.

And then just shifting gears a little bit to Massachusetts and you guys are obviously paying very close attention, that market is developing and there’s some recent comments about kind of targeting 4 to 8 new rec stores per month I think in Massachusetts kind of as a goal for 2019. What’s your sense of how realistic that is?

I know you’re not -- you’re based in California, but I imagine that you’re close to the ground in Massachusetts?

I mean, what we’ve seen out of the regulators there is that they move a little bit slower. So I would probably cut those estimates in half.

But there is going to be meaningful progress. I mean right now, there’s, I believe only 2 stores that are open that are rec.

So even adding another 2 would basically double the market, right? So that’s why we feel very confident saying that we expect to double our Massachusetts revenue every quarter this fiscal year because we do believe there’s going to be more licenses given out that the state needs it.

And those operators are going to see significant spikes in volume. So I would buy on that news, I would say yes, they’re going to give more licenses.

But I would definitely discount the number a little bit, because I have seen them move a little bit slower than regulators in other markets like Oregon or Nevada.

Okay. And then California has also been constrained, I mean obviously with much higher base, but disappointing nevertheless versus the black market.

Is there anything happening in California to kind of maybe if not open the floodgates on compliance stores maybe speeds to ramp of some of these licensed stores?

Yes, the biggest thing that’s happened in California is on the delivery side. There’s been an ongoing battle through the last year of whether or not cities ban delivery, law enforcement was on the side of allowing cities to ban delivery into their city and even delivery passing through their jurisdiction.

That was a losing argument. The straight ruled that delivery will not be banned anywhere in the state.

So I think this is going to be huge. If anyone who has a retail license store is going to be -- is allowed to deliver.

Most of these folks haven’t built out robust delivery platforms yet, but they’re going to. Because there’s a lot of markets that aren't going to allow stores for the foreseeable future and these markets are going to be accessible now through a legal means of delivery.

So I think that's huge news and we should see meaningful throughput there, obviously as I mentioned earlier licensing more stores is important. The state has said look we put it on the city to do it, the cities haven't been moving as fast.

So they'll blame the state, blame the cities I guess, right? But nonetheless we've seen traction, the state expects to double the amount of licenses that they gave in for retail in ‘18 to double that in ‘19 so that would put us at about 1,000 stores which is a decent number.

It's nowhere near enough to service the whole state. But if you add the delivery component in there, you can see the volumes picking up meaningfully when all this comes together.

My first question is for you, Nick, you may want to chime in but I am wondering about -- I know that you have some prepays this quarter and obviously you mentioned the inventory in terms of the Chinese New Year there was some extra spending there. But your cash balance is $3 million.

I’m just wondering what the cash flow projection might be for next quarter? Or if I recall you guys have access to some sort of credit line as well.

Just any color you can provide there would be helpful?

Yes, so obviously cash a little lower than we’d like and the reason why a lot of that cash moving into prepays and moving into actual inventory, obviously we're continuing to convert inventory into cash as part of our ongoing daily selling. So everything right now is focused around Chinese New Year and that's a period basically through the month of February and most of March where there's basically no more inventory coming out of China.

And so we're buying as much as we can ahead of that. We're going to load up on that inventory, we're going to convert that into cash throughout those -- that period and be able to bridge the gap here.

Obviously as we continue to grow, working capital is going to be a challenge. So we're looking at how do we solve that in multiple ways.

And as Chris mentioned we're looking at the credit markets, we do have a line of credit that's currently only at $8 million, we're looking at to upsize that significantly to be able to support some of this. We're also looking at negotiating better terms with our factory partners.

That’s the cheapest form of capital that we could get if we're able to do that. And we're looking to be more efficient with our collections as well.

We have a new credit policy that we've implemented. We're getting tighter with credit for the smaller customers because they're not moving the needle as much for us anymore.

So a lot of these initiatives will help. But ultimately until traditional banking is available and we're very excited to see that the landmark deal that was just done with Canopy Rivers up in Canada $80 million credit at a 5% interest.

If we could have something like that, then great, we could scale this business all day leveraging cheap debt capital. That's not the reality here in the US.

It's improving. We're expecting to see throughput coming to us.

But ultimately we may have to use some equity financing to continue to bridge the gap on the working capital scenario. It's just the reality of the situation.

What we don't want to do is slow down the growth. What we don't want to do is tell customers that want to work with us on that we can't support them because we don't have the capital, the balance sheet and the infrastructure.

We want to be in a position to win and that puts us in a position and we're going to have to figure out how to navigate through this until the market fully opens up, post federal legalization.

Got it, great. Thanks for that color.

And then last question. And that's, you really kind of sparked some interest I think among investors when you talked about how you guys are increasingly doing business with the MSOs in United States and today you talked about dedicated sales unit that's working on that as well as came in.

I am just wondering, what is the -- what are you trying to take them away from, what are they doing now. Just working with a bunch of smaller distributors, are they doing it themselves.

I'm just curious kind of what your sales tactic is with that unit?

Yes, so it's different, there's a big difference between MSOs and the Canadian LPs, it's pretty interesting. The LPs have built out a lot of teams and they have their own innovation teams and their own supply chain management teams.

And so it's a different sales approach up there but the MSOs what we're finding right is that they're all gaining a ton of momentum right, they're drinking from a firehose, their revenue is growing and we've become a real value added supply chain partner where we’re able to take that off of their plate and most of these folks don't have robust teams to manage it. A lot of these bigger multi-state guys have one purchasing person or two or three purchasing people kind of manage the supply chain as they grow and scale.

A year ago, two years ago, they were all relatively small. And when you're small, you can deal with other small partners.

So to your point, we're dealing with a lot of the smaller private partner companies that we compete against. As they've grown, they've quickly outgrown those folks.

And we are -- for what it's worth the biggest cannabis specific provider and so we put ourselves in a really good position to earn that business. Ultimately, folks that have bigger balance sheets than us are going to come into this industry.

So everything we have to do is in building that relationship, the loyalty, creating a lot of value for these folks, having defensible products that have IP, so that we can continue those relationships. But a lot of it is the flight to us because we're the only one that's big enough on this plane heavily in the space today that can support them as they grow and hit their plan numbers that they have out there.

Okay, thank you guys all for the questions. And we know we're a little over time.

So I'll finish with some brief closing remarks. First and foremost, I can't stress how positive this Q1 revenue growth is for our business.

We feel really good that we're able to start the fiscal year with this kind of growth as we haven't historically been able to do that in Q1. We feel really good about the plans that are in motion to approve -- improve the operational efficiencies which will lead to drastic margin improvements over time.

We wish there was an overnight fix, it's simply not, but it's something that is attainable and something that we see the momentum behind already. We do feel confident that with those initiatives we will be able to get the margins back over 30% and that doesn't have as much to do with price increases.

It's really about our operational efficiencies and it's really about our mix shift. We also feel like we'll be able to better optimize our warehouses, better optimize the shipping that we do that that's not above the line but as part of our OpEx and we want to be more efficient across all levels, especially when it comes to warehouses and the warehouse management system will help with that.

Cross-selling is working but it's a long game. We're continuing to execute on that and as we execute, those relationships become stickier.

The relationships are strong. We're leveraging those relationships now to get commitments, we're expecting to be able to announce some pretty large supply agreements at some point later in this fiscal year, as this is becoming bigger business and your supply chain, your supply chain, the products that you need access to on a regular reoccurring basis, it's important for these customers to start locking those up with us so that we can plan, prepare and be able to support them.

And we'll see that throughput in the form of multi-year supply agreements. The hyper growth does put a strain on our working capital.

As I just mentioned on the last question, we have several initiatives in play to improve this and we know it's something that's going to be an ongoing battle as we continue to grow at these rates, but it's something that will become easier over time, especially as federal regulations open up. We were continuing to build defensible modes.

We know that we're doing really well against the competition of today. But we'd be remiss not to be focusing on the competition of tomorrow.

So everything we're doing is focused on that. And how do we build defensabilities, how do we innovate like our stainless-steel tank?

How do we strike strategic partnerships like the one we have with the natural products and also how do we file patents and garner IP. The macro horizon looks very exciting.

The democrats are now in-house causing trouble and we think that eventually they'll get around to enacting some legislation that improves our industry. The Farm Bill did pass and that's going to be huge for CBD especially here in the States and also just general momentum globally.

We see Canada now talking about edibles and vape, so they're tracking towards that. That's huge opportunity for us that we currently can't capture today in Canada until those product classes are available.

And we see countries like Mexico making progress on legalization, Luxembourg, over in Europe legalized for rec. I mean there's a lot of momentum globally around cannabis legalization.

I mean the last thing I'll say is that as a management team, based on the first quarter performance and the pipeline that we see, the relationships that we have and hopefully the supply agreements that we're looking to garner, that we're very confident and want to reaffirm our revenue guidance of achieving between $110 million and $120 million for this fiscal year '19. And the most exciting part about that is that that would be organic growth not factoring in any acquisitions along the way.

So thank you guys. Have a great day.

We look forward to hearing from you, having you guys tune in for our next call. Thanks.