Good afternoon and welcome to the KushCo Holdings fiscal third quarter 2019 financial results conference call. A replay of this call will be archived on the Investor Relations section of the KushCo Holdings Web site 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 the 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.

Thanks, Phil, and thank you all for tuning in to our third fiscal quarterly earnings call. First, I'd like to call out another record-breaking quarter of revenue at $41.5 million, which is an increase of 221% compared to $12.9 million in Q3 of 2018, and on a sequential quarter-to-quarter basis, an increase of 17.9%.

Next, I'd to look at gross margins for the quarter. As we've mentioned on previous calls, we believe we can continue to improve our gross margins without raising prices.

We've mentioned that there has been temporary or one-time-in-nature events that have led to a decrease in margin, and as we become more efficient and as we address some of these issues, we end up getting a lot of those margin points back. For the quarter, we finished at 17.8% margin, up from 12.9% or 490 basis points improvement from the second fiscal quarter.

We're doing this through better management of inventory. We implemented a WMS system on April 1.

We're rolling that out companywide. It's been implemented in our main headquarter warehouse.

We're also renegotiating a lot of terms with vendors, as the company gets scale we have better buying power, and we can use that to reduce our cost. We've also eliminated air shipping earlier this year.

We've also eliminated free shipping to our customers, an initiative that we cut right at the beginning of Q3, and we're now starting to pass-through tariffs, and if we look at tariffs on a non-GAAP basis and pull those out, our margin for the third quarter is actually 22.8%, and when we look at the fourth quarter that will be our first full quarter of utilizing a tariff pass-through. And so, because of all these initiatives, and because we now see margins going in the right direction, we're confident to reiterate our stated goal of getting the company to 30% gross margins over time.

Next, I'd like to draw your attention to the supplemental earnings slides. Again, we're seeing metrics going in the right direction across the board here.

First, we'll look at the geographic sales breakout. Some key points to highlight is continued growth in almost every region, outside of Alaska and other countries, but tremendous growth in some of the key growth regions for us, like Massachusetts, where we're up 784% year-over-year, and up 85% from Q2 to Q3.

Also Michigan, an area where we've recently invested in opening up a distribution center to service Michigan and also the coming Illinois market, we're up 164% from Q2 to Q3, and up 254% year-over-year. So we're very pleased with what we're seeing in regions, even in established regions like Washington, Colorado, Oregon, and Nevada, where we're still seeing tremendous growth even from Q2 to Q3.

Next, we can look at the product mix slide where we show the four product buckets. We are very pleased to see growth in three out of those four buckets.

The papers and supply bucket is the only bucket that was down from Q2 to Q3, and that was due to a inventory issue that has been resolved. So we're expecting to see growth in all buckets for next quarter.

We're pleased to see our packaging revenue grow significantly, 21%, from Q2 to Q3. And we're going to continue to focus on packaging and energy and natural products buckets as they have a higher margin than our vape bucket.

Next, we're going to look at the cross-sell progression, perhaps my favorite slide in the supplemental earnings. We're continuing to see great trends here.

We're getting more customers into these buckets spending over $10,000 or more with us in the last 12 months, and in the large buckets, the $500,000 to $1 million we saw an increase of seven customers from fiscal '18 when we look at the last four quarters. And in the $1 million plus bucket we see an increase from four customers in fiscal '18, to now 13 customers when we look at the last four quarters.

And so what this is telling us is that there's bigger customers now that we're going after, the MSOs and Canadian LPs, and that these customers are spending more money with Kush, and they're able to get more products because our offering has expanded, and if you look at the average number of SKUs that these customers are purchasing, we see these metrics going in the right direction as well. And now customers that are spending $500,000 to $1 million with us in the last 12 months are buying on average 56 SKUs, and customers in that $1 million-plus bucket are buying a tremendous 73 SKUs from us on average.

Next, I'd like to look at our balance sheet. We finished the third quarter with $12.2 million in cash, and inventory including prepaid inventory at $62 million.

Our inventory as a percentage of revenue is higher than average, but that's due to the fact that increased tariffs were announced for the end of Q3, and we were able to quickly purchase inventory ahead of that, allowing us to secure inventory at a lower cost. We expect to burn through a lot of that inventory in Q4, which should significantly help with our cash flow.

In quarters past, we've talked a lot about the financing needs of the business. We know it's a cash intensive model.

We know that the business is growing tremendously fast. And we've expressed desire to find less dilutive financing mechanisms, and keeping with the theme here, we've done exactly what we said we were going to do.

We've been able to secure a $21.3 million senior unsecured term loan, we've been able to negotiate improved credit terms with a lot of our key vendors, and we're actually in the process and expecting to close on a larger credit facility here in Q4 that will better align with our current AR and inventory levels. So, we're proud that we've made significant progress in all of these areas, and now that we have secured better financing and are in the process of expanding our credit facility, we believe that our cash flow should be vastly improved.

I'd like to call attention to our announcement yesterday that the company has filed an application to uplift on to the NASDAQ Global Select Market. While we can't comment on the application status or the timing, we would like to point out that earlier this year two ancillary cannabis companies were able to list on the exchange, one being Greenlane, who listed us as a direct competitor and listed via IPO, and the other being MJ Freeway, which is now Akerna that listed via spec.

In light of these listings, we remain confident that our company will be listed in the near future. Next I'd like to talk a little bit about the future outlook for the company.

First, I'd like to start with the company's vision. Our vision is to power the global cannabis ecosystem, and we're pleased that the company is now positioned to be involved in more cannabis transactions than any other company in the world, given the amount of products that we sell to all of these unique operators, and you're witnessing a transformation of the business, a transformation from at one point where we used to sell a lot of generic items to now having an unrivaled portfolio of proprietary offerings including new products that we're launching from our Koleto division, including signed contracts with large customers for proprietary products specifically built for them, and now we're going into a new phase where we're looking at utilizing unique and proprietary services to better enhance our offering and to make the KushCo ecosystem much stickier for the customers that live within it.

So, we are pleased to announce a partnership with C.A. Fortune, C.A.

Fortune is one of the leading consumer product sales and marketing agencies and what they do is they work with large retailers, specifically in the grocery category, and these are all of your national retail grocery chains and they work with the buyers there to ensure that they have the right brands represented in those stores. We obviously have a great network of brands and with the passage of the Farm Bill it presents a huge opportunity for us to take our CBD brands that we work with and give them the opportunity to get placement into these large retail outlets.

We see this as a very high-margin and high-value initiative, because not only are we solving a problem for our customer by allowing them to build their brand nationally, but we're also solving the problem for these national retail chains who want to get into the CBD and hemp space very badly, but don't necessarily know who the brands are that they should be carrying. We're in a unique position here.

We're now offering this valuable service to our customer base. And of course, if they're able to get placement in these channels, they're going to be buying more of our core items from us whether it's ethanol to produce CBD or whether it's packaging to go around the product.

So the value creation is all around, and there's no other company that's going to be able to offer this type of service to go along with the products that we're selling. This is just an example of one of many initiatives that we have under works to better monetize the platform that we've built.

We feel that we have the most valuable customer network in the world. We're operating across the entire industry through all the key regions and working with all the major players and we can monetize that by selling the products, we can monetize that with these new initiatives such as the partnership with C.A.

Fortune and something that we have upcoming. We're yet to announce it's going to be moving into equipment financing, where we have a customer base that has a high CapEx requirement for a lot of their machines whether it's extraction machines or trimming machines or different testing machines, and now we can offer a financing solution be able to finance these machines so that they can pull cash out and use that to grow their business.

This is something we're expecting to announce in the near future, and it's something that is going to be another high-margin, high-value initiative that's scalable and taps into our existing network and platform. Our initiative is centered upon the development of an ecosystem in which our clients can utilize numerous areas of the business to satisfy the multitude of demands relevant to businesses in the cannabis and CBD industry.

As a result of all this, we want to reiterate our fiscal 2019 revenue guidance, targeting in on the high side of our range of $145 million to $150 million for our fiscal year ending at the end of August. Lastly, I'd like to give a quick legislative and regulatory update.

We obviously are monitoring the industry on all fronts. We're continuing to see tremendous progress at the federal level.

There are several initiatives. There's more pro cannabis rhetoric coming out of Congress and members of the Senate.

We believe that there will be continued progression to normalize, legitimize and eventually legalize cannabis at a federal level. However, we're more tuned in terms of what's happening at the state level, each new state that comes online represents a brand new market for us to attack, in a lot of instances we're already doing business with a lot of the operators in these markets that are turning from medical to adult use and that transition presents an opportunity for significant revenue growth.

The first state to call out is Illinois. The Governor recently signed a bill to make adult use cannabis legal and they plan to roll out that program in early 2020.

With this law, Illinois becomes the 11th state in the U.S. to legalize recreational or adult use cannabis and we believe with the population of 13 million that the Illinois market should be one of the largest markets in the country.

Another notable call out is Michigan, we're seeing tremendous sales growth already in Michigan ahead of the implementation of adult use cannabis and in fact, we recently announced that we're opening up a 40,000 square foot distribution facility in Taylor, Michigan which will be there to support the rapidly growing market in Michigan and the upcoming rollout of the Illinois adult use market. Maine is a state in the Northeast, which we believe, ultimately will be one of the largest regions if not the largest region for cannabis in the country.

We're seeing Massachusetts gain steam now that they're giving out more licenses and Maine which voted in the same time as Massachusetts has finally announced their regulatory program where they plan to open adult use stores in 2020. And lastly, Canada, our neighbor to the north is obviously a global epicenter for cannabis.

We have been working with a lot of the LPs and preparing for the derivatives that are set to come online later this calendar year. We believe that we're going to see a huge boom when they do allow products like edibles, concentrates, topicals, and vape pens.

We were disappointed to see that being pushed back two months but we now have a date that we know the Canadian market will begin what they say is Cannabis 2.0 in December '17, where they can now sell all these derivative products and of course with our portfolio and what we sell that represents a huge opportunity for significant revenue growth in Canada, a market where last quarter was only 2% of our sales. We expect and we look at our fiscal 2020 that Canada is going to make up a meaningful portion of our revenue due to that marketplace coming online with the new rules being implemented and the traction we're getting with the LPs.

And at this point, I'd like to turn the call over to Chris Tedford to discuss the fiscal Q3 financial results.

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

Total net revenue increased 221% to $41.5 million, compared to $12.9 million in the third quarter of fiscal 2018. Increase in net revenue was due primarily to increased selling of vape hardware and accessories, packaging, energy solutions, and natural products.

On a GAAP basis, gross profit increased to $7.4 million, up $3.7 million or 102% from the third quarter of 2018, due primarily to an increase in overall sales. Gross profit as a percentage of net revenue is approximately 18% in the third quarter of 2019 as compared to 28% in the same period a year-ago.

This decrease was due primarily to higher sales concentration of vape products, which generally have lower gross margins as compared to other product categories along with the negative impact from the China trade tariffs. Towards the end of May '19 and in connection with the most recent increase in tariffs, we decided to implement a tariff supplement fee charged to our customers, which we expect will offset the impact of the latest step-up in tariff costs.

On a sequential basis, GAAP gross margins improved by 490 basis points. This increase was driven primarily by lower material costs, better leveraging of fixed costs, and other supply chain efficiencies.

On a non-GAAP basis, excluding the impact of the China trade tariffs, adjusted gross margin was approximately 23%. As of the end of Q3, total inventory was approximately $53 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 ahead of the latest increase in tariff costs, and to support our fourth quarter sales targets. SG&A expense increased to approximately $21 million versus approximately $19 million in the second quarter of 2019, primarily due to an increase in the salaries and benefits, including non-cash stock-based compensation costs, facilities costs, and consulting and professional fees.

However, SG&A expense as a percentage of net revenue has decreased from 53.3% in Q2 to 49.9% in Q3 of fiscal '19. The company actively monitors its resource needs to support its long-term growth initiatives, and continues to evaluate strategic investments in regional warehouse facilities to maximize sales and gross profits in new and emerging markets.

On a GAAP basis, net loss for the third quarter of 2019 was $10.6 million or negative $0.12 per share as compared to a net loss of approximately $9.2 million or negative $0.14 per share in the third quarter of 2018. On a non-GAAP basis, excluding the impact of certain nonrecurring charges as well as other non-cash gains and losses, our net loss for the quarter was approximately $8.6 million or negative $0.10 per share.

We ended the quarter with a cash balance of approximately $12 million, as compared to approximately $18 million as of February 28, 2019. With that, I'll now turn the call back to the operator for the Q&A session.

Hi, this is Gerald Pascarelli on for Vivien. Thanks very much for taking the questions.

Absolutely. Hi, Gerald.

How's it going? So, another strong quarter of revenue growth, just to start, can you just talk about some of the states in particular in 3Q that maybe outperformed relative to your expectations heading into the quarter?

Thanks.

Yes, I think the biggest one was Michigan. We knew that we were going to be up.

We estimated somewhere around 100%, but looks like we're up 164% in Michigan. So we're pleased to see the traction in that state, and now they seem to be fast-tracking the adult use program, so that trend should continue.

The other states that we were really pleased with were actually the legacy states, with Washington and Colorado, both up 26%-27% from Q2. And then Oregon and Nevada, both of those states up 46% from Q2.

So great to see strong growth in more established markets, because if you look at the data, those markets aren't even growing at those rates annually let alone quarterly, like we are, so it shows we're getting more traction in those states and effectively cross-selling to the customers in those markets.

Got it, super helpful, thanks. Can we just touch on Massachusetts, if I heard you correctly, I think you said 85% quarter-over-quarter.

I know that you had previously said you were expecting triple -- I think it was a 100% quarter-over-quarter growth. Is it fair to assume that we should expect a sequential acceleration maybe in Massachusetts in the coming quarter?

Yes. No, great point.

We were expecting the market to double. Again, we almost got there.

But yes, we're seeing strong growth there. I think some of it is due to the pace at which they're rolling out the licenses, and out of our control.

But at this point we would be confident to say that we expect similar growth in terms of percentage for Massachusetts for the fourth quarter.

Got it, thanks. Last one from me, just on the gross margin.

Looks like tariffs were a bigger headwind this quarter, 5% -- five points versus about four points last quarter. Could you just provide some more color on the pass-through that you're anticipating in 4Q?

I know that you said you were going to maybe pass through the incrementalic. Is it the 1% increase that we saw in the margin hit that you're going to pass through or is it going to be more than that?

Yes, so we've implemented the pass-through as of just actually a few days left in the third quarter. So, for the whole fourth quarter the pass-through will be in affect.

What we're actually doing is passing through roughly 100% of all tariffs. So, we're expecting on the next call that we will not have -- for the fourth quarter at least, not have a non-GAAP breakout that includes tariff fees because they should all be offset with the tariff supplement fee.

Again something we weren't doing previously. We're doing it in bits and pieces strategically, and at the 10% tariff it was livable.

And then with the tariff jump we were able to move to a full complete pass-through, and it was understood by the marketplace because obviously moving to 25% tariff is not sustainable for a company like ours. And so, we've been effectively passing that through.

We have not seen many issues at all with that change. And again we expect to see that throughput on the fourth quarter report.

Got it, super helpful. Thanks very much.

Thank you.

Hey, thanks. Good afternoon, Nick, and Chris.

Hope you're doing well. The tariff detail is really helpful.

Thanks for that color. I wanted to pivot to Canada real quick.

Nick, I think it was you at the end of your remarks that used the phrase that Canada could make up a meaningful proportion of revenue when it comes online, referring to the 2.0 Market, if I heard that correctly. Now that we have clarity on the 2.0 Market, can you give us a sense for how Kush thinks its positioned from a business development standpoint.

So what does the competitive landscape there look like for you? And as the LP is ready for that market could we actually start to see meaningful benefits in your P&L as we get out of summer here, ahead of that market actually formally opening up?

Yes, great question. So yes, Canada, it is a huge opportunity because our sales today are not really reflective of the market potential, and we know that that market is going to be growing in a big way come December.

So we're well positioned. The nice thing about Canada is there's only -- there's a few players, right, there's a lot less names than there is here in the U.S., so we're certainly talking to all of them, all of the relevant players up there.

And we've made progress in terms of actually signing agreements with some of the LPs. Now, the agreements that we signed are pretty sizable, but they have not yet realized any revenue for the company yet because these are for custom products that we're in development of and plan to go into production here soon.

We do expect some lift in the Q4 just in terms of what we did in Q3. I think the numbers should be up significantly.

We were up 116% from Q2 to Q3. I would expect the percentage growth from Q3 to Q4 to be actually much higher than that.

So that's a great sign. But in terms of Canada becoming a meaningful portion of our overall revenue that will be probably fiscal '20.

When we look at the full revenue for fiscal '20, we expect Canada to make up as much as 15% to 20% of our total revenue, and so big jumps coming for us in Canada behind the back of these contracts that we already have signed, behind the back of the derivatives coming online in December. And to answer the other part of your question in terms of our competitive position in Canada, there's no other company that does what we do, period, in the world, because we sell all these different unique things.

But as you know, we go up against companies that do certain segments of our business, so we do compete against traditional packaging companies. Unlike in the U.S.

where a lot of the traditional players don't know where to find the customers, in Canada they do. And so we actually do run into the mainstream packaging companies, some of the big multi-billion-dollar conglomerates that everyone's aware of here in the U.S., they're up there knocking on doors.

Now, we're winning business in Canada, we're doing it in a different fashion than we necessarily utilize here in the U.S. We found our niche, our way to compete.

It's a good sign that we're winning business up there even though we're competing against some of these large packaging players. Obviously we're distributing CCELL products; those products are going to be strong in Canada.

We have not yet set up infrastructure for butane in Canada, but we plan to do that at some point. So we're preparing on all fronts.

We have a lot of unique offerings. And now with our new partnership with C.A.

Fortune on the CBD brokerage side we're expecting a lot of the Canadian LPs, especially the larger ones who have determined that they want to enter the U.S. hemp and CBD market to utilize that partnership to be able to get access to some of the biggest national retail chains in the country.

So we expect that to be a compelling offering that, again, nobody else is really offering to the marketplace today.

That's great color. And then I wanted to come back to just broader consolidated margins, and the comment that you made about KushCo pushing towards 30% gross margins over time.

So it's great to see the roll-off of the airfreight and the quality cost issues. Hopefully we'll see the roll-off of tariff costs as they've been very meaningful.

And as I think about mix shift or product mix shift over time, you guys have been on record about wanting to drive your own vape mix down below 50% of sales, I think compared to something closer to, like, 70% in recent quarters. And I just wanted to revisit this as it relates to your push towards a broader target of 30% gross margins, and ask you if this is a realistic endeavor just given the broader popularity of vapes in the marketplace?

Yes, so we've taken advantage of opportunity in vape. There's some balls dropped by some of our competitors and we've been able to pick those up.

And so that's why we ended up similar percentage as last quarter, and not tracking toward our objective of diversifying out of that bucket in terms of revenue percentage. The dynamics around pricing cost of your average vape pen versus the cost of your average packaging container are going to mean that it's going to be challenging for us to move revenue out of that bucket because it's so much higher.

In some instances it's 10 times the price on an average selling price basis. But nonetheless we are still committed to that, and we believe we can over time because we sell so many other things and we're diversifying into new categories and we're seeing tremendous growth with our natural products, that we do believe we will be able to diversify out on a product basis.

And then there's the services, and that's really where you look at the incremental margin improvement. Even if vape remains the same in terms of percentage of our product bucket, just having the service offerings that we're launching is going to help in a significant way in terms of our margin.

And so just to walk through what I discussed on the call, there's two service offerings, that we're launching one of them. We already announced the partnership with C.A.

Fortune. The way that that works in traditional sales marketing brokerage business is that the company that represents those brands brings them to the retailers, the buyers at these national grocery chains.

And then once they're placed into these channels and start generating revenue, the fee is actually just a straight percentage of revenue. And so, our fee structure is going to be around 5% for the partnership.

It's a 50-50 partnership, so half of that fee will flow directly back to KushCo. There's very little cost associated with that.

We did have to hire somebody, a senior VP here to be able to run that. We've already done so.

We've already been working on this. But outside of a couple of hires, there's really not a lot of cost.

So that's super-high margin revenue coming straight to the bottom line. Now you look at equipment financing, which I announced, and we've identified a partner that's a $10 billion fund that wants to back us initially with $75 million.

Now we're still in the early stages of finalizing that partnership. But when you think about $75 million being placed out in the market to finance equipment for cannabis companies -- cannabis and CBD companies we're going to be able to take a margin on that money, let's say it's a margin of conservatively 10%, while again it's going to be likely a 50/50 partnership, and so you are looking at 5% of $75 million coming straight to our bottom line.

And so, again this is another high-margin, high-value initiative, it's going to help balance out in terms of gross profit dollars, these buckets and these more high-margin categories. And that's going to be the path to 30% plus gross margin.

And the nice thing about both of those initiatives, whether it's the C.A. Fortune initiative, we are replacing brands and retailers, there are -- throughput in those retailers is going to leave some more sales of our core products.

Now you look at the equipment financing venture, for financing someone's extraction machine, I hope that we can win a piece of their butane business, their cartridge business, or their packaging business as well. So, if they're gearing up for more production of oil, yes, we are making a nice fee on financing it, but we are also driving more sales of our core items.

Now, these are just two of a slew of initiatives that we have coming out, and what we are trying to show people is that we built an extremely valuable network, we have the customers. Now figuring out all these unique ways to monetize that customer base, that's in one sense the easy part, doing the hard work of getting these into our ecosystem and our portfolio is what the company has been investing in over the last few years.

Very good. I'm going to get back in the queue, thank you.

All right, thanks, Brett.

Good afternoon, guys. Thanks for taking my questions.

First, given the importance of branding, does that continues to grow within the MSOs, are you seeing a shift towards a bigger percentage of the business coming from the cost and branding products, and I guess how has it affected margins as of late, and then could you provide an update on the IP front and any recent progress you've made there?

Yes. So, yes, to answer your question, certainly we are seeing a continued shift away from generic products to more branded products.

This actually works out well for us from a cash flow standpoint, because these products are typically -- they typically pay deposit when we place an order for these products, and then we know that we are only storing the amount of inventory that they have requested that they're going to take within a short period of time. So, there is a lot less inventory risk, and obviously inventory is a big use of our cash, so these trends are going to be favorable to us from a cash flow standpoint.

And we are seeing that the one other thing that is kind of slowing that transition is the market is still highly dynamic, lot of these companies are trying to get ahead of it, they're trying to forecast demand plan, but it's typically to do, especially when new markets like Massachusetts and Michigan are coming online in a big way they're exploding, and these companies are just trying to keep up. So, that's what's keeping some of these items still in the generic side that will eventually move to the more custom branded side.

I mean then of course there is Koleto, our innovation arm, and as you mentioned, what is the pipeline for IT, well, a lot of these customers are saying, "Hey, I used to have a jar, and now I have a jar that's printed, great, right now it's branded. Well, now I want a jar that's unique and proprietarily."

And that's where our Koleto division comes into play. And so, we have been working with a lot of customers now.

Obviously, we are prioritizing customers that have the volume requirements. I mean these are the large Canadian LPs, the large multi-state operators, and we can actually offer this service to them that we can work with their team to design a unique proprietary option, and then back it with a contract so that we can make the investment and the tooling and bring those products to market.

So, Koleto is working in that fashion and also working in terms of innovating and developing our own products. And any of these projects, whether it's for mass market or whether it's specifically for a customer, typically involves us garnering intellectual property that's scalable that we can use across a multitude of different foreign factors, and so we are pleased with a lot of new designs that we come up with, we're filing IP applications for patents on design and utility with the focus more on the utility patterns of functionality around child-resistant closures, making products water tight and air tight, which are the requirements for Health Canada.

And all of this is launching in the coming months, a lot of these stuff that we have been working on for the last six or seven months finally coming to market both for us and for our customers for some of the unique proprietary stuff.

Great, that's really good to hear. And then secondly, it was really good to see the recent addition of the new distribution facility and in Michigan, I was just wondering going forward and looking at your current facility footprint, what markets do you expect will acquire additional facility in the near term?

Well, there is a gap in our geographic footprint with the Southeast and we're gaining a lot of traction specifically in the Florida market although we don't break it out. You will see in our geographic bucket titled Other Medical States that we're seeing tremendous growth there and so at some point that will likely merit an investment, and we're also getting a lot of inbound M&A solicitation and so these numbers are becoming more attractive to essentially buy some of the competitors that have been in the marketplace.

And if it's highly accretive and the deal can be structured correctly, that's also something we're going to look at and so we may inherit some distribution footprint. We want to optimize that, we want to setup our facilities so they're in the right geographies but knowing over time it doesn't make a lot of sense to have a bunch of small facilities and we'll likely be consolidating as the market matures.

Right now it's a competitive advantage and it's necessary and customers are demanding it, but over time, we're going to make this thing much more efficient and that's where you look at a meaningful throughput to our EBITDA number when we start to really optimize and make this business more efficient at high scale.

Perfect. That makes sense.

And lastly from me if I could just quickly revisit the margin expectations, you've obviously talked about them getting a 30% in the 2020 range, I guess could you get a little bit more granular there in terms of the timing within 2020 on when you'd expect those to be achieved?

Yes, I mean, we can't say exactly when we expect to hit the 30% mark. I think the 30% mark as I mentioned on the last question is contingent upon some of these new initiatives and sometimes new initiatives can take a little bit longer to gain traction, but we do have a clear path.

Obviously, if you look at our non-GAAP breakout where we are over 22% in margin due and that was due to point out the tariffs and as I said we've now implemented a tariff supplement fee as is the start of Q4, so that shows you kind of that next incremental margin jump on a GAAP basis if you factor that in. And then of course we're constantly getting better pricing whether it's pricing for better shipping costs as we're importing products whether it's lower cost of product as we get more volume and scale and we're able to renegotiate and upgrade a lot of our supply chain partners.

So expect for that those incremental things to continue to occur and the margin to continue to move up. But in terms of when we can actually hit that 30% goal, I don't have an exact timeframe although we're hopeful that it can happen during fiscal 2020.

Okay, sure. I understand.

Thank you.

Thanks for the questions. First off, just looking geographically at California sales were up just 1% during the quarter.

That is the state we guys had had pretty, pretty robust growth the past couple of quarters. So I just want to know if you could touch something on the dynamics of the market and whether or not you believe is kind of flattish trend was more short term with the market kind of returning to growth over the next couple of quarters and how you're seeing things there?

Thank you.

Yes. Thanks, Aaron, and I'm glad you asked that question.

Definitely notable, it's been a market where it's been growing at a tremendous clip and now it had slowed from Q2 to Q3. Unfortunately, we actually do see this trend continuing.

We do see the California market slowing. It's not necessarily a bad thing for us because we have so many other markets that are growing exponentially.

And the good news, the underlying news is we do expect California to grow to be much bigger than it is today. It's just not going to happen as fast, it's going to happen over a much longer period of time.

So we're going to be able to expect growth in California for years to come, which is great, and obviously we're growing in other markets like Colorado and Washington that have slowed growth, because they're more matured. So, we have no concerns about our ability to grow in these markets even as they do slow, but the overall trend in California is unfortunate, the state is not licensing enough retailers.

We saw a lot of the brands that we work with ordering a significant amount of product to prepare to stuff those retail channels which they have. And now you look go to any retailer in California, you'll see a whole bunch of brands on the shelf and there's no one that's getting a super high turn, the velocity of product moving off these shelves has slowed because of the proliferation of brands and there's only 600 retailers for the whole state.

I mean there're more retailers in states like Colorado and Washington than there are in California and a lot of those sales are unfortunately going to the illicit and illegal retail stores or illicit channels and it's bypassing the legal channels which of course is the only markets that we participate in. So, the only way that it's going to be able to ramp faster, we believe it will ramp strongly over time but it's going to be for the state to give out more licenses, open more retail stores and effectively stomp out the black market with a tactic of providing a better tax incentives and more options for license business while simultaneously cracking down and putting penalties on unlicensed businesses.

Great, thanks. And then just looking at kind of your Other Medical States, we saw another nice up tick this quarter, can you provide some color on the states that are driving that.

I know you mentioned Florida earlier but just kind of some more color from other states such as New Jersey where you're seeing medical cannabis kind of expanded there and how you expect to see I guess Atlanta kind of trend going forward? Thank you.

Yes, so certainly Florida as we mentioned now, they have smokable flower there too, so we're going to see that continue. Mostly outside of Florida, it's the Northeast right the medical markets in the Northeast are consistently growing, New Jersey is expanding their medical program, Maryland, Connecticut and Pennsylvania is the other state where we're seeing, we're seeing growth.

So these medical markets are developing and we look at these, all these medical markets including Florida has been very close to moving to adult use and so we'd like to get our position in the market ahead of time with the medical players and then be able to ride that growth into adult use with them. And it's great to maintain our first mover advantage under those scenarios.

Great, thank you. I'll jump back in the queue.

Hey guys, congratulations on the strong revenue.

Thanks Bobby, appreciate it.

So I guess this is for Nick. Just curious as you look at what's happening with CBD and your plans there.

How much overlap is there really between your CBD and THC, plant touching customers? Is that are these two distinct customer sets or are they somewhat converged?

Yes, that's a great question, and actually one that we often get from the institutional investor community, something we're going to start to try to dive deeper in and be able to segment out because there is a lot of overlap, a lot of these companies are seeing CBD as an opportunity to grow because of the retail access and being able to get the mainstream channels and also there's a lot less red tape and there's not lot of the stuff that the cannabis operators have to deal with like ADE and all the licensing that they have to go through. So we're seeing a lot of people migrate over to have CBD.

It's more scalable and they're investing in it. And so we do provide products for them on both the THC side and the CBD side.

And I would say if I had to guess, it's probably somewhere between 20% and 33% of our customers that are doing that type of crossover. And then of course there's some customers that are CBD only and that's growing as well.

It's becoming more and more whereas originally it was more of the crossover folks. And so we're focused on both companies that are in our existing THC portfolio that are moving into CBD, new CBD entrants and then there's also Canadian LPs who are restricted from coming into the U.S.

except through CBD and hemp. And so we're taking advantage of that and being able to help facilitate their entry into the U.S.

market.

Okay, great, makes a lot of sense. And then given the Farm Bill and different legal status for hemp, CBD, are there things that you can do to kind of extend your involvement in that product line maybe to something that's more plant touching or are you guys staying 100% ancillary?

Yes, I mean we've stayed away from plant touching for two reasons obviously the regulatory component and as you mentioned with Farm Bill that has opened up CBD and hemp to some extent. The other reason that we've avoided it is because we don't intend to directly compete against our customers and we actually want to be in a role of supporting our customers and helping them be more active in the market.

And I see the C.A. Fortune partnership is exactly that.

This is a traditional sales and marketing brokerage firm and it's a multibillion dollar company and a lot of these CBD brands would never have the opportunity to get into a relationship with someone like C.A. Fortune and to be able to facilitate that relationship to get placement into major mainstream retail grocery chains.

And so because of this partnership, we're now giving that access to our customer base. So more things like that that are enabling of course selling our normal products and our ethanol for CBD production, selling our packaging for the CBD brand, everything that we think about is how do we enable our customer base, how do we power the global cannabis ecosystem and there's more things that we have coming out that can help do this but I think C.A.

Fortune partnership is a big step in terms of getting our hands into the CBD market in a big way and expect to see more of that in the near future.

Okay, great. And to stay on CBD and combine it with the hardware a little bit, I understand the mix has been a little bit challenging with innovative hardware wondering how the mix of hardware and kind of product roadmap looks like in that side of the business as we add CBD only vaping products, is there something that's appreciably different about what that roadmap looks like and what your involvement might look like on the hardware side?

Yes. No, there is opportunity for CBD vaping, a lot of our customers are already taking advantage of that through the same hardware platform that we sell on the THC side which is CCELL, CCELL is by far and away the most reliable and consistent best performing hardware and CBD oil is different, it's typically less viscous but there's the devices have been built to be able to handle that oil as well.

And we're in constant, it's really a partnership with CCELL and so we're in constant communication with and dialog with them about how to make improvements to better capitalize on this opportunity. And so there's new stuff coming out from CCELL such as pod systems which will be great for the CBD marketplace as well.

And your margin in terms of what that looks like versus your overall margin in that business, is that accretive to your tape hardware margins?

Well, it's about the same on margin percentage basis but the pod systems are more expensive. So on a gross margin dollar basis, we'll be generating more gross profit dollars per unit on a lot of these new pod systems although the percentage wise it's in line with what we traditionally see from that category.

Great, thanks a lot.

All right, thanks, Bobby.

Thank you, good quarter, guys. Just little quick follow-up on the CBD, have you guys provided kind of breakdown of revenues there or expectations you can break it down into separate segments going forward, how can be that?

Yes, that's a great point. We're going to take a look at how we can give more clarity around CBD and hemp as it becomes a more meaningful portion of our business.

Also for some people that are maybe wary about cannabis and THC, it's something that certainly de-risks the business and so as we've gained a significant portion of the business to move over to that category; it would be helpful I'm sure to be able to break it out in a better way. So we're going to work on that, but as of now, we don't have any specific numbers to quantify what we're doing on the CBD, hemp side versus the THC side.

Okay, thanks. And you guys provide a lot of clarity, a less rule question is kind of category strength.

I know last quarter you've talked about natural products and then kind of what's energy services opportunity up in Canada. How you guys are looking for that going forward?

Well, right now, there is no butane activity in Canada but we see that opening up. So for butane, we like to set up our own delivery hubs.

So currently, we don't have any infrastructure in Canada but that's something we can set up quickly because we have an asset light model that we execute on for setting up those hubs. Ethanol is something that we can sell in Canada.

And we've made significant improvements into our supply chain there to be able to be highly competitive and become a main player in that market. So we're going to -- we're going to be investing there.

I forget the first part of your question, if you want to repeat that?

Category strength on the quarter like natural products, what kind of stuff…

Yes, so natural products we remain bullish, also a product category that translates well to CBD. We saw growth in the category not as much growth as we'd like to see.

But we have our new stainless steel tank coming out for butane. We expect to be able to take a bunch of market share when that launches here in the coming months, we have a huge pipeline of customers that are going to be transitioned over to our natural products from other competitors.

So we're expecting that category to continue to grow significantly. The one category that we were down in was the papers and supplies and as I mentioned that was due to a supply issue where we actually had to return a lot of product that was not up to quality and that we believe is all behind us as we've made significant investments with our partner to upgrade the quality of manufacturing for our paper cones and it's now operated out of GMP certified ISO facility that is producing these cones and we've switched to better paper providers as well.

So we're bringing paper in from Europe and producing these cones in India and we expect that category to start to gain traction as we're in the process of walking into meaningful contracts around that.

Okay. Then just last little thing, you guys brought on some employees on the finance side, SOX's priorities any other potential new employees from that side of things?

Yes, I mean, we expected headcount to be flat, it was actually up. We do expect it to flatten though and there was a bit of a transition, one of the things is lot more people want to work in the cannabis industry today than they did even a year ago or certainly two or three years ago and so a lot of what we're doing is bringing in some really top tier talent, it takes a while to get up to speed.

There's a big learning curve and then that allows us to eliminate some of the redundancy and become more efficient. So we expect headcount to certainly flatten, some of the people that we have brought on as you mentioned in the finance department an area where we have to be extremely strong.

We obviously have a microscope on us being in this industry being at the forefront trying to uplift the company to NASDAQ. And so, we have to make sure that we're doing everything to the best of our capability and we're being ultra compliant.

And we're in the process of implementing Sarbanes-Oxley which is obviously takes resources, so we had some headcount there. We also have the two initiatives that I spoke about both for the partnership with C.A.

Fortune which is signed in ink and we're in the beginning stages of launching. And also the equipment financing venture which we are going down that path already, we've hired high level VPs to run both of those initiatives.

So we've already front loaded some of that. So there's been some strategic hires that have ROI attached to them, that have led to an increase, little slight increase in headcount but overall I mean we're doing more with less, the headcount growth has significantly decreased.

Now, we look for that to flatten as we have better technology, better systems or WMS system eliminate lot of the warehouse headcount that we had. So everything is going in the right direction.

And there's been some one-time fees and expenses that we've incurred that some of it's associated with the uplifts, some of it's associated with these new ventures that we spoke about, some of it's associated with the M&A opportunities that are now coming our way that we're getting. And all of it should lead to really good ROI and return for our shareholders.

But these are investments that we're making. The core business is becoming more efficient and utilizing less resources.

So it's a lot of this new stuff and new opportunities that are dragging down resources both on the head count personnel side and also on the capital side.

Got it, thanks.

Yes, thanks very much. Good afternoon.

Just a follow-up question on Canada, as we look at -- Nick, I appreciate your comments on the growth potential in that market in fiscal 2020. Could you talk a little bit about the margin potential?

It's a big country geographically, so obviously maybe freight costs might be little higher. There's competition on packaging.

I don't know what pricing is like, not asking for too specific data but with somewhat more consolidated market, should we look at that revenue base potentially in the future as maybe perhaps being a little lower margin or not necessarily the case. Thank you.

Yes, great, great question. I've said before the business in Canada because of those dynamics right, you've talked fewer players that are more consolidated in the marketplace in a bigger scale.

They're obviously going to want better pricing. And so in some instances, we will see margins lower than what we would see maybe in the U.S.

But the trade-off there is this is more predictable revenue. A lot of doing business with any of the large LPs you're going to be entering into supply contracts, some of which have volume guarantees associated with them and so we can plan and prepare against that revenue and we know that they're going to take the products.

So it's better for cash flow. And so we're getting better more consistent margin chunks even though the margin percentage might be a little bit lower.

But the other positive news with Canada is a lot of what we're locking in is actually in our higher margin buckets. So we're locking in a lot of packaging contracts, we're in the process of locking in contracts for our papers and we're also in dialog about natural products, and so, whereas in California and a lot of our U.S.

markets we've been leading with vape. In Canada, we're actually going to be leading with products that are in higher margin buckets.

And so that should offset any concern that Canada as a whole will be margin negative for the company. We expect there really to be margin neutral and in line with the rest of our business.

Great, that's very helpful. And I apologize for this but I was writing something down Nick, when you mentioned the revenue guidance for the fiscal year.

Could you just repeat that? Sorry.

Yes. So we last quarter I really raised our guidance to $140 million to $150 million.

In this quarter, we basically honed in on the top end of that range guiding to $145 million to $150 million for the full fiscal year.

Perfect. Thanks very much, and congrats on the quarter.

Thank you.

Hey Nick and Chris, thanks for taking my questions.

Sure Alan. How are you doing?

Good. Just a couple, well, first of all congratulations, I know you're not across the finish line yet but very exciting to be this close to the NASDAQ and I want to follow-up as you've always talked about one of your key competitive advantages being your stock.

And that was an OTT stock. Now that you hopefully will be on the NASDAQ, I imagine this will help your M&A strategy.

So I thought this might be a good time to just update us just a little bit. You've talked about consolidation of other distributors but I'm curious what types of acquisitions beyond that that you might be interested in.

And also if you could give us some sort of guidance about your expectations on the size. Will these be small acquisitions going forward or might you contemplate a larger one?

Yes, great questions, and certainly exciting on the NASDAQ front as we mentioned, we can't comment on timing but we're very hopeful that it's going to happen in the near future. So that would open up a big opportunity to continue to utilize the stock in a more efficient way.

To make acquisitions, I mean we've said consistently that we believe the stock is trading much lower than it should. When you look at the last two acquisitions we did, they were priced at $5 a share which is basically where our stock is today.

Now since that time period at least since the Summit acquisition which happened in May of last year, I mean we've nearly tripled the business. We took advantage of getting aligned with a lot of these more high value customers and now we're launching high margin initiatives to complement it.

So certainly there's not a lot of appetite to utilize the stock at current levels but the expectation would be after the results and showing the margin improvement that the stock will trade higher especially with NASDAQ up listings and at that point, we would be a little bit more aggressive. We will go out there, we will look at direct competitors and take them out.

We are seeing across the board that the capital markets have really dried up for new entrants. And so, you've got the companies that are public and this is the whole sector and obviously you know more than anyone, Alan.

But seeing these companies that are now public, they are going to be the ones consolidating, they're going to be the ones buying their competitors and new brands and new markets. And it's no different with us.

I mean we don't have very many competitors that have access to capital markets but certainly the ones that have not, there's not going to be a clear path for them and so at this point they're getting more traditional EBITDA multiples. And if we can pick up a business at an EBITDA multiple and a multiple sub one times revenue which is what we're getting from inbound solicitations then we will look to do that especially if it's a transaction where we can utilize our stock at a higher price.

So that's the path that we're looking at consolidating some of our supply partners to be able to add significant margin to some of our offerings. That's another strategy that we're looking at and delving into more proprietary offerings via acquisition is something else that we're considering.

So those are kind of the three areas as of now direct competitors consolidating some of our supply partners and being able to get margin expansion and then also looking at companies that have intellectual property that's extremely defensible being able to add those into our portfolio.

Great, thanks. And just you've talked a lot about Canada, the 2.0 that's about to kick in.

I just had a few questions because and I would have thought that vape would really be where you're heavy but you're talking about other types of offerings and I don't know if that's more on the retail side, but when I look at the Cannabis 2.0, we're talking about basically single serving edibles in beverages as well. Do you have packaging solutions for those markets in it?

Yes, we've been working with LPs with our Koleto division to come up with them. We're also seeing a transformation where a lot of the product was going into traditional medical channels which as you know is through the postage system there, through the mail system and also a lot of the adult use cannabis has been sold online and shipped via Canada Post.

So now what we've been working on is these LPs are saying, hey more retailers are coming online. This is going to be more of a traditional retail consumer product good experience maybe going with the cheapest generic packaging solution isn't the best idea to build my brand nationally maybe upgrading my existing flower packaging or pre-roll packaging into something that resonates better with the consumer is the direction that we should go and so that's again led to opportunity for us.

So, some of it is going to be replacing products that you would see in Cannabis 1.0 with more branded consumer-friendly options, and then some of it is also going to be taking advantage of Cannabis 2.0, where we're coming up with packaging for vape pens, packaging for edibles, packaging for beverages, and then of course the vape pens themselves and the natural products and the energy and all the other stuff that we can sell that with the derivatives that we couldn't sell previously.

Got it. Okay, well thanks a lot, congratulations on the progress.

All right, thanks, Alan. Appreciate it.

Hey, Nick, Chris. Congrats on the quarter, guys.

Honestly, a very thorough call here, just a couple of clarifications. I thought I heard you say 15% to 20% of your total sales for fiscal '20 would include Canada.

Is that right or am I off on that?

No, as shocking as that sounds, that is what we anticipate.

Okay. The, I guess the view --

And again this is based on numbers that we're receiving from our customers. And so I mean we like to think everybody hits their numbers, but -- and sometimes it's just people don't, and so some of that is out of our control, but that's what we're anticipating.

Okay, good. The consensus view I think is around $240 million in total sales for you guys in 2020.

So, obviously that implies $36 million to $48 million from Canada. Sounds like you have some good visibility on that, but given the work you've done on your budget so far, is $240 million in the right zip code?

Well, we haven't given out guidance yet for the fiscal year. But obviously you guys are doing the math.

You're looking at our growth rate on a sequential quarter basis, and so certainly the numbers that you're suggesting are in line with what historicals have been, but we're going to take a deeper dive during this next quarter into fiscal '20. We're also looking at a path to profitability, which we've guided to in fiscal '20.

And so how that will maybe adjust our revenue a little bit as we focus more on profitability. We haven't got through all of that yet, but we intend to and have an update on next earnings call in terms of where we expect to be for fiscal '20, certainly on the revenue side, and potentially on the gross margin side or profitability side as well.

All right, good. That'll be interesting call.

I guess for your profitability goal that you reiterated for fiscal '20, what is your implied percentage from vape? And to become profitable is that -- are you [ph] assuming just organic growth through continued cross-selling, new geos, new international markets, like Canada or are you also thinking or implied some M&A deals into the mix?

Yes, great question. I think what we're modeling for vape is about two-thirds of our business, somewhere between 60% and 66% of total sales.

Now, as I mentioned, some of the new initiatives that we're launching are going to be more bottom-line related and not top line. So if we're bringing in, let's just say hypothetically, we're able to place 10 CBD brands into 10 of the biggest grocery chains in the country, hypothetically they could generate $100 million of annual sales through those chains.

Well, our commission on that is going to be 5% to the partnership and half of that Kush. So you're talking about $2.5 million straight to the bottom line.

Now, it's not going to help our top line, it's not going to balance out our product buckets in terms of percentage, but it is going to be a meaningful part of the profitability story. So there's that, there's the equipment financing which, as I mentioned, if we're able to make even 5% on $75 million, that's a big number coming in to the bottom line in terms of compared to other gross profit contributors.

So really we kind of have to look at this as revenue mix, but more so gross profit contribution mix as we start to get into these new higher margin initiatives.

Great. Last question, the 15% to 20% from Canada in '20, is that primarily an existing client base or are you adding new accounts that show indications of interest.

And then also how much of this is product being expected to be slowed in the U.S. from CBD versus sort of the native Canadian market related to cannabis, obviously CBD is illegal in Canada?

Yes, so these -- I wouldn't necessarily call them new customers, but these are folks that we've been in dialogue with for months and months, some instance six to seven months, and a lot of product development work. And there may have been a few purchases, but the lines that we're expecting and some of the product lines that we actually have in contract already, those are all brand new.

And so we're getting those numbers based on the contracts and what's -- actually some of it is being guaranteed. And those contracts, we're also getting some of those numbers based on forecasts for these new product lines.

But this is something that, again, we're always being conservative with. And some of it is market dependant.

But we think that with these opportunities there's enough to make up that 15%. And I forget the second part of your question there.

How much is --

Oh yes, the -- yes, we're not estimating -- in order to hit like on the low side there, like the 15%, we're not estimating a lot of that to come from U.S. CBD, most of that is the numbers we're getting for Canada and export globally on the THC side.

Okay, great. And the vape products for Canada, obviously that looks -- you look at the Canada Health, there's sort of barbaric about the edibles market, but vape seems to be probably the category leader in the 2.0 launch.

Is there a tariff on your vape sales to Canada, or can you sort of go direct from China to Canada and avoid the tariff?

Yes, it's a great question. I believe we can avoid the tariff.

And if that's incorrect I will certainly circle back with you, but I believe Canada -- product coming straight from China to Canada is tariff-free.

Great. All right, thanks guys, appreciate it.

Good luck.

Bye. Thanks a lot.

Okay, thank you. I want to thank everyone for joining the call today.

We truly appreciate the long-term support from our shareholders. We are building something extremely valuable, powering the global cannabis ecosystem and facilitating more cannabis and CBD transactions than any other company in the world.

As with all great things, this will take time, but you are seeing a transformation of the business. Starting with generic product offerings, now we're offering a full suite of proprietary products and innovative solutions, like our stainless steel gas tank which is set to launch in the coming months.

And now we are striking partnerships with multi-billion-dollar companies and launching our own initiatives to have an unrivaled, unique, value-added service offering to pair with our robust product portfolio. The net result of this transformation will lead to increased margins, better operational efficiencies, and eventually meaningful profitability.

We look forward to giving you an update at the end of the fiscal year. Thank you, and have a great rest of your day.