Good afternoon and welcome to the KushCo Holdings fiscal second 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 fiscal Q2 earnings call. First, I’d like to start with the sales update.

First and foremost, another record-breaking quarter with revenues of $35.2 million, representing an increase of 240% compared to $10.4 million in Q2 of 2018. This quarter's revenue represents a 39% increase from Q1 to Q2, up from $25.3 million last quarter.

Over the past 20 quarters, the average quarter-over-quarter revenue increase is 27%. Now, when you look at the supplemental earning slides, and specifically Slide 3, showing our geographic sales breakout, what stands out the most is California continuing to be the main driver of sales representing 58% of our sales in Q2, and we remain confident that other markets are going to start to catch-up at a rapid pace, while California continues to grow.

The $20 million in California was a 273% year-over-year growth, and a 46% Q1 to Q2 growth. Massachusetts, another state to call out, as we believe the Northeast market is going to continue to grow at a dramatic pace, up 788% year-over-year, and a 136% from Q1 to Q2.

As I mentioned on the last call, we expect over a 100% growth in Massachusetts each quarter this fiscal year. Next, I want to look at another slide in the supplemental earnings deck, Slide 4, where we talk about mix shift.

Our mix shift has been a big focus of us -- of ours at the company, and we have a goal of getting our vape revenue below 50%. Obviously we’re still growing that as a percentage.

We expect that long-term we can decrease it and reach our goal. However, in Q2 69% of our sales were from vape and we were pleased to see that 11% of our sales came from our energy and natural products division and the primary driver behind that was Natural Products.

We entered into a new partnership in October, November timeframe of last year. The company that we began working with was generating only around $100,000 in monthly sales and we are pleased that we were able to grow that to the point where in February, the last month of Q2, we reached almost $600,000 in sales of natural products and we're seeing demand for that category increase across the board as well as our positioning with our new partnership.

Over the last 12 months, we had 20 customers spend more than $500,000 with us, 10 customers spending over $1 million with us. A full breakout if you're in the cross-sell progression side where we see customers spending more money with us are moving up higher into different buckets and doing that by way of cross-selling.

We see that customers are spending over $1 million with us on a last 12 month basis are buying on average 70 SKUs from us. That's a huge metric that we like to track because it shows us that we're going deeper and wider with our existing customer base, we're able to generate more dollars, we're able to enhance and increase our margin and we're able to make a stickier relationship worth more defensible long-term.

Next, I'd like to talk about working capital. First, I want to refer to our balance sheet and I have a few callouts there.

Number one, cash improving from Q1 cash of $3 million. For Q2, ending cash of $17.9 million.

This was mainly driven by the registered direct offering we did in January with $31 million in net proceeds and we were able to take some of that cash and we were able to put it into inventory and you see inventory growing up from $17.4 million at the end of Q1 to almost $36 million at the end of Q2. We loaded up on inventory, Chinese New Year happened right near the end of our Q2, and we wanted to make sure we were prepared with enough inventory to continue our aggressive sales goals through Q2 and into Q3.

Next, I want to talk a little bit about the nature of our business. As I talked on previous calls, this is a working capital intensive business.

We have to constantly define more inventory as our sales continue to ramp at a rapid pace. But we're buying products for some times two to three months out because of the lead times and transit times and we happen to buy products two to three months out, somewhere between a 30% or 50% increased rate.

So we're buying more product than we're selling today. And as a result, we're going to constantly be in a negative working capital scenario.

And now we'd like to fix this working capital scenario with less dilutive measures and there's really three primary ways that we can do it. Number one, we can work with our current vendors and factory partners and we can get better credit terms, and we've been doing that.

We're making significant progress there, including recently as a few weeks ago receiving credit terms from our biggest vendor and those will start to go into effect here in the coming weeks. We are going to continue that initiative.

We're also looking at another way to solve it, which is leveraging debt financing and credit facility. We currently have $36 million in inventory.

We've got over $10 million in receivables and we’re only leveraging $4 million to $8 million on our current credit facility. We know that the assets justify a larger amount of credit than is available to us today.

But one of the things that has been working against us is the banking environment around cannabis. We see that improving.

We see larger funds now coming to the table wanting to talk about credit facility. These aren’t through traditional bulge bracket banks things yet.

But we believe with continued progress in Congress and with the States Act, that not only is going to open it up for larger traditional lenders but ultimately it will completely open it up banking for the largest of the banks in the country to be able to start working with companies like us there in the cannabis industry. So we remain very confident that we're going to be able to improve our debt financing relationships here in the coming future.

And of course the third way that we can fund this working capital is through equity investment and we’ve utilized this in the past. We will continue to utilize this as necessary in the future because the last thing we want to do is slow down our growth.

But we recognize that of the three ways that we can offset our working capital demand, equity financing is the most dilutive. And so, we would prefer to leverage ways one and two prior to going to three but we're going to continue to do whatever is necessary to grow the business at the pace that we’re growing.

Now, we’ve also made some internal changes than have been incremental in improving cash flow. I wanted to go through those really quickly.

Number one, we were able to discontinue free shipping as of March 1st. We were able to reduce costs on many of our top-selling items, including recent cost reductions we received a week ago on some of our top-selling SKUs.

We were able to reduce our percentage of cash tender that we receive, a handling cash obviously has a high expense to it and we are seeing more of our clients be able to access credit unions and banking facilities and that translates to a cheaper cost of cash handling for us as we're able to get payment in wire and ACH form. We’re also optimizing our warehouses to make sure that we've stopped inventory across all our facilities.

This will start to reduce in and eventually eliminate unnecessary cross-country or cross-region shipments as we can ship from the most efficient warehouse. We’ve also implemented an initial round of tariff supplement fees.

This is a very small start but it's something we will continue to expand upon as we look to offset the tariffs in hopes that the tariffs will eventually go away altogether here at some point. And lastly, we’ve started implementing mandatory take clauses in some of our customer agreements.

So we’ve had customers that have ordered custom product we had at our warehouse and now we’re requiring that, that product to be shipped within a certain timeframe, so it doesn't tie up the ton of capital sitting on our shelf. Now, I would like to quickly address our Q2 gross margins.

Our gross margins has been a big topic on previous earnings calls and we’re very pleased to see margins going in the right direction as we continue to execute on the strategic initiatives that we’ve touched on in the past. We do breakout a non-GAAP table.

You will see here that we've adjusted for non-reoccurring airfreight costs, we've adjusted for non-reoccurring product quality costs and we've adjusted for Section 301 tariffs. Right now we’ve talked about in the past air freighting and we’ve talked about product quality issues.

And we've done a lot to be able to improve in those areas. We believe that you'll see some impact in Q3 but it should be dramatically less and you should see relatively no impact in those areas in Q4.

So that's all going in the right direction. Now, the biggest drag on our margins is actually the tariffs.

We paid almost $1.4 million in tariffs in Q2, none of that was offset by any tariffs supplement fees charged to customers, so we ate that. We did that strategically as we've been doing to continue to maintain and grow market share.

It's an investment. We are looking at offsetting it.

As I mentioned, we've implemented some tariff fees. There are probably more to come.

We're going to continue to look to recoup this incrementally in Q3 and Q4 with the hopes that the tariff war is going to end very soon. Now, we have also filed for an exemption on tariffs for some of our core items and we do believe that on this core items we are entitled for that exemption.

Should we be able to receive that exemption, we would actually be able to go back and recoup these fees that we have paid for those specific products. We maintained our goal of getting our margins back up to 30% and we believe because of this we are well positioned to achieve our goal of getting to profitability by fiscal ‘20.

Next, I'd like to look at some of the strategic moves that we've been making. We've been making significant investments to get the company to a certain scale.

We’re starting to get to that scale, although, more scale is coming as we continue to grow revenues. What this scale is doing for us is it’s increasing our purchasing power which is allowing for cost reduction.

It's also eliminating risk of clients trying to go direct as we are having such a great price with a lot of these new vendors that we can sell to, not only customers but other distributors because our scale is allowing our cost reduction to go beyond further what other folks are able to get if they go direct. We're also seeing operational efficiencies.

We are now optimizing our warehouses. We've implemented Manhattan WMS system into our main warehouse hub.

We’re seeing significant cost savings already from that, an impact from that will likely be in Q3 and continued impact into Q4, as we rollout the WMS system to our other facilities around the country. And because of this scale we’re also able to fund our exclusive and semi-exclusive opportunities, including joint ventures, and we're going to look to continue to take advantage of those as we can.

We know we have one of the best footprints in the industry. We've got the largest sales force out there.

We've got relationships with all of the key clientele. And as a result, folks that are coming to market with products are coming to us first and giving us exclusive or semi-exclusive opportunities to distribute and sell those products to the marketplace.

And we’re also developing our new products with our Koleto division. We have several products that are rolling out here in Q3 and throughout the rest the fiscal year.

These products are going to be highly innovative. They're going to have IP.

We're going to be able to maintain higher margins and we're going to be able to get customers who -- some of these products have been designed specifically by and for customers. We are going to be able to get committed long-term volume contracts from these customers.

And lastly, we're going to continue to stay focused on growing our core business. Our core business is really lining up the opportunity.

It's huge if we just continue to execute. We have all of the pieces in place but we're also building now and extremely valuable network.

And as we're monetizing it through our core business, we're also examining other ways to monetize that same network. And we believe that we should have some strategic business units evolve out of our current strategic planning where we can better monetize the network we work so hard to develop.

So what does all this mean? It means that you should continue to see revenue grow organically at a very rapid pace.

You should start to see SG&A as a percentage of revenue start to decrease, headcount as a percentage of revenue continue to decrease and you'll see net losses continue to decrease each quarter as we track toward our goal of profitability in fiscal '20. Next, I want to talk a little bit about our sales pipeline.

We believe that we're in a great position with our current infrastructure. We believe that our sales force, having boots on the ground in all these key markets that are actively developing relationships with key players, is a strategy for success.

We're seeing that success. We're winning new business.

We're getting our current customers to buy more different products from us. We're ultimately in a position to be a first mover in every single new market as it comes online.

And we're growing revenues at a very rapid pace and the revenue growth that we're seeing is primarily organic. Because of this continued revenue ramp, because of the sales pipeline that we see in front of us, we're very confident in raising our fiscal 2019 revenue guidance from where we were at a $110 million to $120 million up to a $140 million to $150 million range.

And we believe that we can accomplish this revenue growth on an organic basis. So if we look at doing any M&A activity, it would only be on top of this robust growth.

Next, I'd like to comment on the restatement of our past financial reports. As noted in our press release issued on April 9th, the company announced its decision to restate its prior period financial statements for interim annual periods within fiscal 2018 and 2017 for non-cash items related to its acquisitions of CMP Wellness, Summit Innovations and The Hybrid Creative.

Although restatement did result in adjustments to the company's historical operating results, the adjustments did not have any impact to the company's net revenue, gross profit or cash flows from operations for any of the restated fiscal periods. As we enter into M&A deals, we typically enter into an earnout structure whereby the acquisition price is directly tied to the actual performance of the asset post acquisition for some period of time.

As the stock moves up and down during these earnout periods, we have to accrue as a liability against where we believe the earnout metrics will land at the end of the earnout period. Previously, we were not accruing for this liability in accordance with GAAP standards.

I would like to note that this error was identified by our new CFO Mr. Chris Tedford.

Unfortunately, our previous finance team and technical advisory consultants missed this issue in previous periods, dating back to May of 2017. I commend Chris and his team for flagging this issue and working swiftly to make the appropriate corrections while addressing it head on.

As we continue to mature the company while striving to be best-in-class in all areas, it is extremely important that we continue to upgrade our financial controls and overall compliance. To this matter, we have retained a national accounting advisory firm to assist the company in developing and implementing its internal control structure in accordance with COSO and SOX 404.

In addition, we have been working with legal counsel to ensure the company is operating with the utmost compliance including making upgrades to our KYC policy, restricting sales from certain geographic areas and requiring verification of license status for hazmat delivery items. Lastly, I'd like to take a couple of minutes to address the future outlook.

First and foremost, there's plenty of opportunity in some of these emerging markets. I touched on the growth in Massachusetts.

We're seeing tremendous growth in Michigan as well. I think they just voted for adult use.

We think that the Northeast as a whole is going to be eventually bigger than the California market. Obviously, we’re seeing significant success in California.

And so, opening up the Northeast is going to be huge for our business. Canada is a market that began adult use sales in October of last year, a fairly lumpy start.

We're seeing that in our numbers as well. The underlying trends are great for Canada.

The LPs are really stocking up. They are starting to prepare for not only the robust recreational growth that they are seeing in Canada but also some of the international markets that are opening up.

So we remain very bullish on the Northeast opportunity. We remain very bullish on the Canadian opportunities and we’re very excited about the upcoming opportunity in Michigan and the Midwest.

In terms of at the political level that we had a big win with the Farm Bill recently passing. That really sparked a huge opportunity for CBD.

We're seeing a lot of the customers that we were working with in CBD start to grow there volumes. We’re seeing a lot of the customers we were working with in THC start to move into CBD.

We have opportunities in CBD for of course packaging, baking, also our energy and natural products division, specifically ethanol, and also with branding services through our Hybrid Creative. There can be a lot of CBD brands looking to launch or reinvigorate themselves in light of this Farm Bill.

We’re seeing other positive progress at federal level. The SAFE Banking Act is something that is going to likely get approved in our opinion.

We think that this would unlock a lot of the banking that were not having access today and it would also unlock the major exchanges for companies like us. We're continuing to make progress in listing the company on a major exchange.

It’s something that we’re working-on on an ongoing basis and we do remain confident that an uplift theme will occur in the coming months. We also are looking at M&A again.

We know that our position is very strong being a market leader with access to capital. We’re seeing a lot of the smaller companies that have been underfunded start to look for exit, they are coming to us.

We're able to structure accretive deals. We may do some M&A while we don’t expect it to be anything that’s gigantic from a revenue or size opportunity, looking at things that are strategic, putting us into accretive categories, putting us into accretive markets that went out strong.

And we believe with our position that, however, we structure these deals, we’re going to be able to get an arbitrage effect in our multiple. At this point, I’d like to turn over to Chris Tedford to discuss the fiscal Q2 financial results.

Thanks, Nick. I will now turn to our second fiscal quarter 2019 financial results.

Total net revenue increased 240% to $35.2 million, compared to $10.4 million in the second fiscal quarter of 2018. The increase in net revenue was primarily due to increased selling of vape hardware and accessories, energy solutions and natural products.

On a GAAP basis, gross profit increased $4.5 million, up from $2.9 million in the second quarter of 2018 due to an increase in overall sales. Gross profit as a percentage of net revenue was equal to 13% in the second quarter of 2019 as compared to 28% in the same period a year ago.

This decrease in gross profit is primarily due to a higher sales concentration of vape products which generally have a lower gross margin, as well as some air freight and product quality costs that we view as short-term in nature, along with the negative impact from the second round of China trade tariffs. As we've communicated on prior calls, we've implemented several strategic sourcing initiatives to address these supply-chain challenges.

However, based on the timing of when our products sell-through, the related financial impact will not be realized until the back half of fiscal 2019. On a non-GAAP basis, excluding the impact of these recent supply-chain issues and the current trade tariffs, adjusted gross profit was approximately 20%.

At the end of Q2, total inventory was equal to approximately $36 million, as compared to approximately $12 million as of the prior fiscal year-end. The recent ramp in inventory is due primarily to a build in inventory leading up to Chinese New Year and to support our Q3 sales goals.

SG&A expense increased to approximately $19 million versus approximately $13 million in the first quarter of 2019, primarily due to an increase in salaries and benefits, including non-cash stock-based compensation expense, facilities costs and professional services fees. The increase in SG&A reflects the company's focused investment in solidifying its operational platform to allow to properly scale the business and to support its long-term growth projections.

Company expects its headcount and other SG&A expenses to flatten in the back half of fiscal 2019, leading to better leveraging of its cost base. On a GAAP basis, net loss for the second quarter of 2019 was $8.9 million or negative $0.10 per share, as compared to a net loss of approximately $7.6 million or negative $0.12 per share in the second quarter of 2018.

On a non-GAAP basis, excluding the impact of the non-recurring charges previously discussed, as well as other non-cash items, our net loss for the quarter was approximately $7.8 million or negative $0.09 per share. We ended the quarter with a cash balance of approximately $18 million as compared to approximately $3 million as of November 30, 2018.

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

Hey, Nick and Chris. Can you give us Nick some more color around your aspirational [Technical Difficulty] for the cadence and timing in order to get there?

Sorry, you cut out Paul. Can you repeat that?

Yes, sorry. I was asking about gross margins and if you can give us color on the cadence and the timing in order to get to your aspirational 30% margin.

So can you give us more color on that?

Yes, absolutely. Thank you for the question.

So look we’re pleased that we're going in the right direction. Obviously, we break out the non-GAAP table which would show where those margins would be if we had some of these non-reoccurring expenses and the main one there is tariffs, so that's -- timing on tariffs is somewhat out of our control.

I don't believe we can get all the way to 30% with those tariffs unless of course we're able to fully offset them with tariff supplement fees charged to our customer. And like I said we plan to do that incrementally over time, while hoping that the tariffs go away altogether.

But I would say you should continue to see incremental improvement, margin should tick-up each quarter Q3, Q4 and then really the 30% goal is built into our fiscal '20 plan, which is one of the enablers allowing us to get to profitability in that fiscal year.

Okay, great. And kind of a high level question, in terms of changes in the marketplace, in terms of competition and specifically would Greenlane come in to the public markets, can you give us a feel for how much you overlap with them?

Yes. And it's great to see Greenlane being approved by NASDAQ.

There is obviously some precedent there to open the door for companies like us. However, the businesses are vastly different, Greenlane does focus on a completely different clientele.

Most of their sales are to smoke shops and head shops, and lifestyle stores and they also sell tobacco products throughout the country, I'm including drool products. So we don't any tobacco, we don't do any of the consumer devices, or bongs and pipes and things like that.

We don’t sell any of that stuff. We also don't sell to any smoke shops or head shops which are federally legal customers.

Even though the businesses we sell to are great businesses and they're fully compliant on a state level, our customers are all in the cannabis and CBD industry and for the most part they are tactically in conflict with federal law because of the federal illegality around cannabis. Now Greenlane does provide some packaging products to the same customer base that we're targeting.

And so, there's a little bit of overlap in the businesses. But for the most part, the businesses are pretty different in my opinion.

And I think it's exciting to see them progressing ahead because it is a cannabis B2B business that is going to be listed on the NASDAQ and that's obviously a goal for us, and so, kind of hoping to follow on the footsteps there, here in the coming months.

Great. And a question for Chris, I mean on the heels of the accounting changes of late, maybe give us a feel for some of your near term and intermediate term priorities and maybe some of the recent other hires you've bolstered your accounting team with lately?

Sure, yes. Thanks, Paul.

Yes, absolutely, near term priorities obviously are related to our SOX compliance. We did note out there that we have hired a national accounting advisory firm to support the company with their call it voluntary SOX compliance and firming up the effectiveness of our internal controls.

We do have -- we do look to continue to upgrade the financial talent and the team. We'll be looking to build out the internal audit department along with some other more technical folks.

So my first question is on the strength of the revenues in fiscal 2Q, quite impressive, meaningfully ahead of what we were looking for. Any specific call outs in terms of drivers of upside relative to your internal expectations, either by geography or by category?

Yes. We remain pleased with the growth in California.

I think, we're seeing some of the growth slow a little bit around the flower packaging, which has impacted our packaging category and it’s due to some of the rules here. But, what we're seeing obviously is vape continuing to be very strong, especially in California.

So, I’d say that’s the biggest driver, in the Massachusetts starting to become a real market with opening of Worcester [ph] in November of last year. Like I said, Michigan was pretty surprising to us, growing 150% basically -- or it actually was 215% from Q1 to Q2.

So, Michigan is interesting. I would say, it’s just across the board, and even the medical states which we don’t break out seen tremendous growth there, 500% year-over-year and 75% from Q1 to Q2.

So, I’d say, it’s holistic for us. I’d say, the other big thing is the customer base.

We’ve been -- it’s a longer sales cycle, getting into some of these larger players, the multistate operators and the Canadian LPs. So, we've seen some of that start to roll in, in Q2; that should only ramp as we move to Q3 and Q4.

And there is some big stuff we’re working on in Canada that we’ve been working really hard and put in a lot of effort and we won’t even be recognizing revenues until Q1 of next fiscal year. But these are massive projects.

So, I would just say, the kind of the three highlights would be obviously vape, these markets that I called out, and then also the mix shift of our customers into these larger players.

Perfect. That’s really helpful.

And then, as we think about the positive revision to your full year revenue outlook, does that really just reflect the strong momentum that you’ve seen in your core business in the first half of the fiscal year or is there any of CBD embedded in that upside?

Yes. It’s mostly due to what we saw in the first half of the year and some of these custom projects that we’ve been working on.

So, when we are working with some of the larger players, it’s typically not stock items. So, we’re either doing branded items, which take a little bit more time or we're doing complete custom builds of proprietary packaging products.

And that takes a significant amount of time. But, once we get it rolling, presumably that would be very long-term, reoccurring business.

So, I think that’s one of the things, obviously the numbers from the first half, the other thing is the pipeline given some of these project that we’re working on. And then, of course, there is some incremental added upside like the performance of the natural products, which is really taking off, and so, we’ve modeled that out to be bigger in the second half than we had originally thought.

We also got up to a slower start with our paper cone joint venture due to some issues that we are having getting that production up and running. And so, we see the quality there start to improve, we’re not able to count on those numbers as well in the back half of the year.

So, a few of those things as well driving this but yes, it's just coming at all angles and new markets, new customers, existing customers, so we felt pretty confident to be able to raise that guidance.

Okay. That’s really helpful.

And then, just last one on the gross margin, if I heard you correctly, you eliminated free shipping March 1. Can you offer any color on what kind of gross margin lift that alone could have?

I think, we were looking at a couple percentage points, 2 to 3 percentage points. And what we did in terms of eliminating that, we’ve been measuring the impact since March.

There has been very minimal impact to sales. It's only affected us a little bit on our online sales, which is a small portion of our overall sales.

And so, it's great to see that there has been little impact. And I think, ultimately 2 to 3 points is kind of where you can model on the free shipping throughput.

So, first question I have, just want to dig a little bit deeper into California. Great to see that sequential momentum continuing there and actually accelerating.

So, could you just give some color in terms of what you're seeing in the industry? I know that some where we've seen a lot of battling with the black market; it hasn’t evolved as much as some people have liked.

But, you guys are doing quite well there. So, just any outlook there and what you guys are expecting going forward in terms of sequential growth this year and how is that going to continue into next as you continue to -- the black market kind of slow down and legal sales kind of increase?

Yes. I think, the California opportunity remains very large because of this dynamic that you are describing, the black market is still hurting legal businesses.

One of the big issues in my opinion is the lack of legal licenses for retail. One of the things that's really helpful to offset that is the -- I guess a law that allows for statewide delivery.

That law was under a lot of threat. It seems to be okay for now, although it is facing lawsuits from certain cities.

But as long as these licensed retailers are able to deliver to any region in the country, now these -- a lot of these folks are building out these delivery networks today. They are not necessarily in robot existence.

They can effectively compete. I think it's about access.

Right? If you are going to have somebody forcing to drive 30 or 40 minutes to buy legal cannabis when there is a black market store or black market dealer within a 5 or 10-minute drive, it’s a very hard sell, especially when the cost is cheaper at the black market outlets than it is at the legal outlet.

Now, I think as we get more accessibilities, more retail licenses, more opportunities for legal delivery, that's going to ultimately continue to drive the momentum in California. The other problem that we are seeing in California is a lack of clean flower.

And so, that's put a little bit of a damper on the flower sales in the market. That should correct itself, the state finally now was able to extend some of the -- put temporary licenses and also starting to approve some of the permanent licenses.

So, it is a big infrastructure that’s required here in the state and it's just going to take a little bit of time to get all in place. And I think, the battle in the black market, it has to be a two-pronged approach.

It has to be licensing more legal businesses that can help compete on a pre-market basis combined with enforcement and legal action against the illegal business. And it seems that there is momentum in both of those fronts, but still a lot of work to be done.

And I think that's why when we look at California, it's going to be steady growth here for a while because it's something that's going to continue to improve but it's not going to change overnight.

And then, just one more question in terms of the long-term supply agreement that you guys announced earlier this year. Just any color, you can give in terms of those partnerships, whether not there they are here in the U.S.

or in Canada? And then, also in terms of potential margin impact and any detail you can provide on the product mix and what we can expect from a margin perspective there?

Yes. So, those supply arrangements are in motion.

Some of those customers are actually ordering and orders are ramping. Some of them we're still in R&D and we're going to be coming out with product soon that will start to have an impact to the top line and bottom line.

In terms of margins, obviously at these volumes, the margin gets a little bit tighter but we can be much more efficient. So, as we’ve talked a lot about margin, there's a difference between direct material margin and our reported margin.

And a lot of that extra operational expense that’s going above the line is due to fast moving environment where things are dynamic and changing and we're having to react rapidly and try to satisfy customer needs. In these larger supply arrangement deals, it’s a lot more planned out, and so we can prepare for that and be more efficient.

One simple example is for our vape products because they're turning so high, we're shipping a lot of those in. If we can lock in these type of contracts, then we can take those products and put them on the water and ultimately be able to reduce our cost of freight, getting those here to the United States.

So, even though the direct material margin on some of these larger contracts is going to be less, obviously these customers would expect that; they're spending a lot of money with us. We can be more efficient with how we deliver, essentially offset that impact and still maintain a margin that's within our expected range that'll allow us to continue to track toward our expected goals.

This is Luke Perda on for Brett Hundley. There's been some larger MSA deals announced in recent months.

We would expect the consolidation would broadly be good for your own business. But, can you guys take us behind the scenes a bit and talk about the conversations that happen after these announcements take place?

Are any companies solely focused on price concessions, do you find that there are numerous opportunities to take share from your competitors, is there a discussion about changing packaging types? Any color on this would be really helpful.

Yes. Certainly a lot of activity now here in the U.S.; you saw a distinct type of activity happen in Canada in years past.

So, it's to be expected, further consolidation, the big difference between the U.S. and Canada is it’s going to be very difficult to become really consolidated in the U.S.

due to the difference in the state laws and the lack of ability to do interstate commerce. So, expect it to still be a fragmented market, even though some of these multistate operators are going to continue to gain size.

In general, this plays to our advantage. We compete against the people that know the cannabis industry, that have the right product sets to service these operators.

They're all small, they're all pretty much companies that have been growing organically and recycling their retained earnings, not raising outside capital, not building robust infrastructures. And so, as these companies consolidate and get bigger, they outgrow those types of providers, and that plays right into our hand.

Fortunately, the companies that do have infrastructure, especially on the packaging side, they just don't have the knowledge, they don't have the right products, they don't really know how to provide comprehensive solutions yet for this industry. And so, we're in a great spot.

And as a result, that's why we're getting so much business coming our way and our pipeline is so robust. Now, we are dealing in Canada as well, which is a market that is much more consolidated; it’s obviously a market that’s legal nationally.

And so, they don’t have the interstate commerce restrictions. And we see a totally different type of customer out there.

So, on one end of the spectrum, you have your large Canadian LPs who are very well-funded, they are looking for the most efficient cost on all of their goods and they’ve got robust purchasing and procurement teams in place. And they are playing -- we're doing projects right now for vape items and beverage items, packaging around that and different hardware.

And that’s just not even in the market yet, it is expected to be in the market in October but that's just an expected date, and yet they are still -- they are going hard right now and preparing all these products. So that’s one end of the spectrum.

And if we are able to play there, that’s great because eventually the U.S is going to start to look more and more like that. Now, the complete other end of the spectrum is the guy that still calls us on his phone because he needs to order another four or five cases of charge, [ph] right?

And we're able to basically service the whole spectrum of the customers base while seeing a lot of the customers move more into a sweet spot where they become a little bit more efficient and we're able to do higher volumes of business. But we’re still able to provide a comprehensive solution.

And keep in mind, in cannabis a lot of these operators, they may already have scale on certain items but they are launching new items. They don’t have -- they may be strong on flower but not on vape, they might be strong on vape but not on edibles or pre-rolled joint.

And so, there is always new opportunities as well where we can get our foot in the door. And then as we provide exceptional customer service and high quality products at competitive prices, that lends to cross selling.

And you can see in the metrics that a lot of these larger customers are spending over $1 million with us actually buying more items from us. So, there is a convenience factor in it as well.

So, I would say, to sum it all up, this trend that you’ve identified today and for the foreseeable future is working really well to our advantage. And certainly we’re going to continue to monitor how we create a lot of value as the marketplace changes.

Thank you for the added detail on that. And maybe as a follow-up, are you seeing producers becoming more focused on their cost expense lines.

From a staffing and talent standpoint, how well set up do you think you are for what ultimately could be a bigger volume opportunity ahead but also more sophisticated buyer?

Yes. I mean, look, if you talk to any of these guys, they are all going to tell you it's still the second inning, it's still the third inning.

It's very early days. And I would say, it’s a unique scenario where a lot of us as businesses left the public at a very young age because we don't have a venture capital market like they do in tech, where you’re able to stay private and raise hundreds of millions or billions of cash and continue growing your business at a rapid rate.

We’re in a weird situation here in the cannabis industry where everybody’s gone public to raise capital but as a public company, you also have a quarterly report where people are focused on numbers. So, of course, there is going to be some focus from these public companies on their bottom line and making sure that their costs are efficient and accretive.

But, you're crazy if you're in the cannabis industry today and you’re focused on making money and not grabbing market share and building a sustainable, global brand. And that's where our customers should be focused on, and that's where a lot of them are focused on.

And ultimately if there is a reliable supply chain partner that can take care of a lot of these things as spin your head and takeaway bandwidth. Why not utilize that and then take your resources and your bandwidth and your internal folks and focus them on sale, marketing and building brand and building infrastructure.

And again, I think, this marketing they are doing, it's what we're seeing in the marketplace.

Thank you. And just one more here.

Can you help me give us a sense of what proportion of its portfolio is commoditized and what proportion is more value-add, either through distinct supply relationships or IP added by the company prior to resell, and what's the realistic target for this mix over time?

Yes. It's a great question, and it's something that I think is often missed in our story and people look at us and say, can anyone do that?

And obviously the answer is no or else more people would be doing it. But, there is a lot of underlying reasons as to why, and one of them is our intense focus on building proprietariness to our business.

We're doing it in virtually every way that we can think of. So, all we do -- right, we have a business model that’s working extremely well.

We are winning business. We’re taking care of our customers.

That's easy blocking and tackling. So, all we do as the senior leadership team is focused on, okay, how do we make this defensible, how do we defend against the competition of the future?

And of course one of the best ways to do that is to continue to innovate and be an innovation leader. So, we started our Koleto division not too long ago, they've been very focused on bringing products to market.

These are going to be proprietary products where we garner IP. These products are going to either be for mass market sale or they are going to be specifically tied to certain customers.

Now, unfortunately, when there is a very large customer that wants to spend $10 million, $15 million, $20 million annually on a custom project, we prioritize that. So, we've been pulled in a lot of different directions, but we have our own products launching soon, we have some of these custom projects for customers launching soon.

And so, we're doing a lot on the product side for packaging and we’re garnering a lot of IP. And so, I don’t have an exact percentage.

We have products that we are selling today, some of our top sellers that are unique and proprietary. But as a whole, we still have a very large what you would consider a more generic or products that could be commoditized long term.

We're trying to shift that and we are from products that again ultimately are biggest advantages having cost reduction and having product in stock over to products where we have an IP advantage and nobody can knock it up or compete with us. We're doing it on our gas and energy side.

We just rolled out our first patch of stainless steel tanks, tremendous positive feedback in the market around this. Now, this is just very early but what we intend to do is replace our entire fleet with stainless steel where we intend to go to state regulatory bodies and we intend to ask them to keep the public safe by making sure the gas is being delivered in stainless and not carbon steel.

This is going to be a huge opportunity to take over the entire market, but it's something that starts with a little bit of innovation. And again that's off to the races.

But we’re obviously partnered with CCELL who is a leading vape technology. We're one of the four distributors for them.

But, again there is some defensibility there. And then, now that we've finally built this network completely out and we have scale and we are connected with all of these customers, we’re getting more and more opportunities to take over exclusive relationships.

So, if somebody has a product, they are going to come to us and say, hey, I want to get this into cannabis and I know you guys are the ones to come to help us. And so, expect for that percentage and I don’t have the numbers, but we will work on that, but expect for that to only grow as all these initiatives are in effect.

Hi. Thank you guys.

Good quarter. Real quick, a lot of questions are answered.

But, I wanted to talk about on cannabis sourcing, manufacturing improvements, kind of working with your manufacturers overseas and kind of mention improving your operational processes, kind of touch base on that real quick.

Yes, a great question, Scott, and something we've obviously talked on previous calls. We're in a situation where the car's going 90 miles an hour and we're wanting to go faster, so we have to get out there and we have to fix the engine and improve it.

So, it's not easy to do but we've been working on this steadily since last summer. And Rodrigo has been really the driving force behind that which is why we were confident to be able to promote him into the COO role.

We have basically upgraded a lot of our factory partners, we've gone from factories that you can go to if you're just a start up off the street to now factories where you can’t even talk to them unless you're talking about a $10 million per month volume commitment. So, we couldn't do it three or four years ago, but now we're at that phase where we happen to transition.

And we have so many different products made from so many different types of materials that we have to start with what the core products, where we can get the most cost advantage due to our scale and then we have to do it throughout the entire supply chain. So, it'll be an ongoing process, but we've already had some major wins.

And we have products that we've done cost reductions of 40% to 50%. We've been able to get products now produced in clean room environment, so they're coming with much higher quality and there's much less aftermarket quality control that we have to do.

It's an ongoing process. Supply chain is a big focus of ours.

If we can execute on supply chain, then we're going be able to win business and we're going to be able to keep business. And so, it's critical.

And then, operational efficiency as well, growing out the WMS system was a big win here in our main HQ in California and we're going to be rolling it out throughout the rest of our facilities by the end of the fiscal yearend.

Okay. And then, one follow-up on the energy side.

Are you still continuing to expand geographically from that side, and just little more color on the natural product side, going deeper into that?

Yes. So, energy and natural products remains a very exciting category for us.

Obviously, you've talked about the stainless steel tanks and the butane opportunity; ethanol, we're starting to get some big customers on that front as well, mainly for CBD extraction due to the farm bill. We are our expanding our hazmat, butane and ethanol footprint.

We are considering opening up in Michigan, both for warehousing and for hazmat. Canada ahead of the ability for these companies to start producing oil-based products and beverages and edibles, we're considering opening up hazmat fulfillment up in Canada as well in addition to warehouses.

So, there is some expansion we're going to do on all of those fronts. But, we still need to get the scale in our core markets.

We open up a facility, there's some fixed cost involved in that. And so, that brings our margin down.

Now, as we start to get scale in those markets, margins on butane should be able to reach 50% or higher but we’re not there yet in every market. So, we’re continuing to pump sales in the markets where we already have placements and that we're looking at expanding as well on the new markets where we see the opportunity.

Hey, guys. Congratulations on the continuing momentum.

And Chris I want to call out your effort. I really appreciate.

I know people weren’t happy about the restatement but to come in, to find something and to address it so quickly is very commendable.

We appreciate that. I mean, certainly, we -- obviously whenever we see, we want to dig into and make sure that you focus on high quality financial reporting.

So, I have just a few quick questions. The first is if somebody is looking at a high level, not listening to the conference call, they might not understand the use of cash to fund the inventory purchase this quarter.

It’s been [indescribable] for the question, so I’m going to ask it. You guys have raised capital over the last year, roughly twice, are you able to provide any guidance on when you might expect to need to raise capital then?

Yes. I mean, we can't provide clear guidance on that, Alan, but certainly a legitimate question.

And I think that’s why I wanted to give the color on the call just about the ways that we can utilize -- our vendors who utilize credit facilities or debt to be able to offset the working capital demand versus going to the equity market. And I think that’s a big factor just in terms of timing and in terms of when we're going to need to go back to the equity market.

We certainly would love to get a $75 million credit facility from Bank of America at 6% interest to fund our inventory. That’s not available today.

So, in absence of that we’ve had some great conversations with some really strong lenders that are getting appetite for working with the company like KushCo. And it’s only a matter of time before we land one of these deals.

And so expect to see a continued improvement and leverage on the credit and debt side, expect to see continued improvement in leveraging our vendor factory partners, especially as we get the scale and become a more meaningful player for them. And then, we’re probably going to have to go back to the equity market at sometime as well, just being realistic.

And the hope is that we can do that as least often as possible.

So that’s leads to my second question about going -- following -- going back to the capital markets for equity, and that is the NASDAQ. Can you -- we’ve been talking about this for a while; it’s a little bit frustrating just to see that the NASDAQ -- isn’t it odd situation right now where it has several companies that are clearly violating federal laws, indirectly, like you guys are, indirectly, yet there are some companies that aren’t promoted on it at this time.

So, can you clarify whether or not you guys have actually implied it? [Ph] I know you’ve been working through this.

And then second -- no, that’s really it.

Yes. And Alan, if you're frustrated, can you imagine how we feel over here?

Obviously, there is a lot of hypocrisy when you look at companies that are listed on not just NASDAQ but NYSE as well versus their appetite for listing other companies, like us. And you can make obviously logical arguments.

But, at the end of the day, it's upto them. They're going to make a decision if they are comfortable listing the business or not.

We’ve spent a lot of time in identifying what those key factors are, what they're looking at when they're making that decision. One of them is, in my opinion, is they want to make sure that there is really no outright illegality that is present.

And we’ve made changes to our business to ensure that. I mentioned restricting certain geographic areas from sales; we’re also on the butane products; we're verifying licenses before we deliver where we saw some potential indirect violation issues that we have there and we quickly move to fix it.

And so, we're doing everything we can. I can't comment specifically on the application.

But, we've been working, it's a ongoing process. We've had external council.

We've had dialogue with both exchanges. With Greenlane obviously everybody's asking, well, if they are listing, why aren't you listing.

And it's not black and white as we've discussed. The other major difference is that 80% of their customer base is technically federally legal under tobacco laws, there is just smoke shops and head shops.

Whereas 80% of our customers are multistate operators in cannabis brands who are legal at the state level but they are federally illegal. And so that's the challenge that we have to work through.

And ultimately it's only a matter of time. I mean, I think the Safe Drinking Act would really give them comfort in being able to list someone like us.

We're going to continue to execute. We do -- as frustrating it is to not be able to move where we feel we belong, we are doing pretty well in the OTC market, and OTC market has been great for us.

And so everybody is just going to have to bear with and trust that we’re doing everything within our power to accomplish that goal.

In addition to Greenlane, I was really pointing to the NASDAQ [technical difficulty] with very clear language including most recently Tuscan Holdings, [ph] before that [technical difficulty]. So, can you just clarify on that build?

Have do you actually apply or you're in discussions with NASDAQ, and if you’re in discussions, what would be the next step?

Unfortunately, I can't comment on whether or not we've specifically applied to one of the exchanges. But, we remain in dialogue with both exchanges and we remain in a position to be able to move to whoever gives us the opportunity to list sooner.

And then, my next question [technical difficulty] interested in M&A and you’ve laid out the case of how at least for competitors, they were not able to scale as the industry is scaling? How those might be I guess customer relationships or maybe some different types of services and products than you guys have.

But, are you able to at a high level, talk about what we should expect in terms of your M&A efforts, are we talking about small deals, or will we see anything as large as CMP Wellness?

Yes. I think, you are not going to see really anything as large as that just in terms of percentage to our core business.

And that's due to our ability to get a state velocity and sort of outpace a lot of these other players. So, when we look at deals, it’s a lot less compelling than it was at that point.

From a revenue standpoint, revenue percentage standpoint, a lot of these deals aren't going to necessarily move the needle for us. From a product standpoint, we’re already getting best cost and a lot of emphasis; we’re actually supplying some of our competitors with their products.

And so, we're not able to really get a benefit there. And then, the larger, high-value customers are coming to us anyways because they’re getting to a certain scale that they're outgrowing those folks.

So, we're getting more selective. The deals need to be essentially more accretive to make sense.

And if we're going to spend our energy and efforts to do it, it's got to be highly accretive from a revenue multiple and looking at businesses that can help get us toward our goal of profitability, so something's that's EBITDA positive and pumping out cash. It also needs to be something that is strategic and getting us into a certain geography that we're not as strong and helping build out our infrastructure or getting us into a new product set.

And obviously, we've expanded by acquisition into vape, we've expanded by acquisition into hydrocarbon gases and solvents, we've expanded by acquisition into creative design services. We've also organically launched our own innovation arm.

We could have done that via acquisition, we chose not to. We've also gone by joint venture into getting into the natural products.

So, there's a lot of more efficient ways that we can now start to get into these other verticals versus acquisition. But, if there's a compelling story that makes sense on accretive standpoint, the deals are getting more -- the prices are coming down, just put it that way.

So, I think we will do some deals. I don't think, they're going to be significant like CMP was in terms of revenue percentage.

Great. My last questions is TILT Holdings recently bought Jupiter.

And I'm just wondering if you could discuss kind of what that means for your company going forward.

Yes. So, Jupiter is one of the distributors of CCELL products and one of the original distributors market, Jupiter actually helped CCELL create the products and they've done a great job.

They serviced the market really well. The main difference between us and Jupiter is going to be our product offering and our infrastructure.

Jupiter operates out of 3PL facilities. They don’t own or operate any of their distribution centers.

They also primarily only sell vape products whereas we have all of our different products including products that are part of the vape supply chain. So, you can’t produce oil putting vape pen without some type of solvent, butane or ethanol et cetera.

You can't have a flavored vape pen without natural products and you can't sell a vape pen in the marketplace without packaging. So, we've built around vape a lot.

And I think obviously that gives us a big advantage for a customer that’s looking for a one stop shop solution. So, that's the main thing.

The other challenge with them is I think they’ve put a lot pieces together. And I think at the outside kind of looking in, trying to figure out where all the synergies are and maybe there's a little bit of conflict as well when you're actively trying to sell products to multistate operators, but you're also essentially a multistate operator yourself.

So, we know those guys well, we have a good relation with them, they're good guys, they’ve built a great business and CCELL distributors, we don't really look at ourselves as competitors. We work together in a lot of instances.

And like I said, Mark specifically the pioneer for working with CCELL to help develop this product in the first place.

Within vape, do you guys break out how much of it is CCELL related?

We're pretty established as a CCELL partner. At this point, the majority, almost all of the revenue is from CCELL.

Although we do buy some batteries and other stuff from other factories but we have some product quality issues with other factories. We quickly pivoted and aligned well with CCELL because they just happen to have the best product quality in the market, the most scalable solution.

And so, even though there is better margins to be made working with other factories, we’re just all about product quality and keeping our customers happy so that they’ll buy more items from us. And we found that it’s much more effective to be able to do that with our partnership with CCELL.

All right. Thank you.

My closing remarks, I’ll make them really brief. We're very pleased with the revenue growth.

We’re very excited about the future, robust pipeline for sales. Our cross-selling metrics continue to be a cornerstone of our business.

We’re very pleased to see customers that are spending over $1 million with us buying on average 70 different SKUs from us. We think this makes highly defensible.

We think this makes our relationships much stickier. We're excited to be launching more proprietary products, continuing to shift away from generic products and selling more innovative products that we’ve created ourselves or acquired rights to.

The innovation arm Koleto is pumping out very high quality work. We’re also excited about a partnership we recently announced with Iosco IEKO, who is a pioneer in the biodegradable, compostable, sustainable arena.

And we know, in this industry -- it's an industry that’s very green in every sense of the word and packaging has been a black eye where there has been a lot of waste. And certainly we’ve taken the stance that first and foremost, it should be about compliance and making sure we have the right products that work for the products that they need to package and that meet and exceed the regulations in the states.

And step two now is trying to transform those products into products that are also earth friendly. And we’re really excited to be leading the charge there and we expect some big announcements coming soon in that vertical.

We're excited about the opportunity in these emerging markets with Massachusetts really getting in this game, Michigan, Midwest coming on line and Canada as well. We have the team in place.

And as we're hitting scale, we're going to look to start to capitalizing on that operating leverage. Looking at a macro level, cannabis is gaining momentum here in the U.S.

and globally. We, at a local level -- Massachusetts just opened their first store in Boston area and that’s huge; Florida now is allowing flower sales, that's another big unlock on the medical side; California is taking strides to clean up the black market at the federal level, the Safe Drinking Act, the state’s act all seem to have a lot of momentum.

The new Attorney General is seemingly very willing to protect state’s rights on this issue and potentially even putting some substantial legislation in place. We continue to be focused on corporate governance and financial controls.

We're pleased to have made significant upgrades in our internal and external resources to be able to support the highest level, the best practices. Although we do believe our stock is trading at a much lower multiple than our cannabis peers, we're also confident that if we just continue to execute and stay focused on the long-term growth plan, the market will take care of itself and respond accordingly.

We remain confident in our ability to continue growing our gross margins with our goal of 30% and we remain confident in our goal of being profitable in fiscal 2020. We're pleased to be able to raise our guidance dramatically through a range of $140 million to $150 million.

And that's it from me guys, and thanks again for your time. We really look forward to keeping you updated on our upcoming Q3 call.

And we're going to continue to put our heads to the ground and execute. Thank you.

Bye.