Valens Company Inc (VLNS) 2021 Q3 法說會逐字稿

Hello, and welcome to The Valens Company's Third Quarter Fiscal 2021 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Everett Knight, Executive Vice President of Corporate Development and Capital Markets of The Valens Company. Everett, please go ahead.

Thank you, operator. Good morning, and welcome to The Valens Company's Third Quarter 2021 Financial Results Conference Call for the period ended August 31, 2021. A replay of this call will be archived on the Investor Relations section of The Valens website at thevalenscompany.com/investors.

Before we begin, please let me remind you that during the course of this conference call, Valens management may make statements, including with respect to management's expectations or estimates of future performance. All such statements other than statements of historical facts constitute forward-looking information or forward-looking statements within the meaning of the applicable security laws and are based on expectations, estimates and projections as of the date hereof. Specific forward-looking statements include, without limitation, all disclosures regarding future results of operations, economic conditions and anticipated courses of action.

These forward-looking statements are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. For more information on the company's risks and uncertainties related to forward-looking statements please refer to our latest annual information form and our latest management discussion and analysis otherwise known as MD&A, each as filed with the Canadian securities regulatory authorities at sedar.com or on The Valens Company's website at thevalenscompany.com.

The risks described in the annual information form, which may cause the actual results, performance or achievements of The Valens Company to be materially different from estimated future results, performance or achievements expressed by the forward-looking information or forward-looking statements, are hereby incorporated by reference herein. Although these forward-looking statements reflect management's current beliefs and reasonable assumptions based on the current available information to management as of the date hereof, we cannot be certain on the actual results that will be consistent with the forward-looking statements in the future.

We caution you not to place undue reliance upon such forward-looking results. For any reconciliation of non-GAAP measures measured and discussed, please consult our latest MD&A as filed on SEDAR. Now joining me on the call today are Mr. Tyler Robson, Chief Executive Officer; Mr. Sunil Gandhi, Chief Financial Officer; and Mr. Jeff Fallows, President.

With that, I would now like to hand the call to Tyler.

Thank you, Everett, and welcome to everyone that has joined our earnings call to discuss our results for the third quarter ended August 31, 2021. I will start by giving you a recap of our most recent highlights and review all we have accomplished over the last year before Jeff goes into more detail on our operational and strategic accomplishments from the quarter, Everett discusses our corporate development and capital markets activity. Sunil will also give an overview of our financial results for the quarter.

First of all, though, I want to start by saying we acknowledge it was a challenging quarter that we're not shying away from. But at the end of the day, the business is stronger, and we did make strategic initiatives to move the business ahead. I'll probably start by talking about some of the challenges first, including the supply chain. I think we all know COVID has been a challenging time for us, but we're still making strides ahead. And as we continue to strategically move the business, there's been some delays in manufacturing capabilities or even automation. So it's not that we're not doing exactly what we said we're going to. We are. It's just taking a little bit longer than expected, whether it's delays in physical equipment coming into K2 or even getting packed in from Europe to come commission some of the equipment.

So we've seen some delays, but we're still extremely confident on where the business is going. Just to add to again how we are confident, we obviously saw strong growth in the quarter as evidence of Valens successfully transitioning into a B2C and positioning as one of the fastest growing LPs in Canada. B2C revenue lines represented roughly 50% of net revenue in Q3, and we expect this to continually grow. Provincial sales growth of 20% quarter-over-quarter supported by 76.5% increase in consumption level at retail was outpacing our competitors. Our motto has always been fewer, bigger, better, and I think we are seeing that. So again, I want to make sure people understand the difference between a SKU and a listing.

We are still running under the model, fewer, bigger, better, and we're also kind of adding a new one, create, build and optimize. As we are building new markets into B2C, we're now looking at optimization, not only through optimization of automation, but also looking at delisting a few nonmoving velocity SKUs and really doubling down on a few of the big ones. Also, when you look at a few of the accomplishments in the quarter, looking at the acquisition of Verse and the pending acquisition of Citizen Stash which falls down in the flower category, we still wholeheartedly believe those are strategic moves.

Verse amplifies The Valens' provincial listings, and for the example of BC God Bud is the top 5 seller in flower SKU during September in Alberta, Ontario and BC, according to Hifyre. Another thing I'll touch on briefly is just the market innovation. Again, I don't think anyone can touch us on the market innovation for not only what's already launched, what's coming in the next few weeks and kind of some of the products we're working on. One of the big things you'll see out of Valens is our infused pre-roll SKUs. I don't think anyone else can touch our capabilities there.

We've seen a few infused pre-rolls that I'll call sub-par to the premium category, and you're going to see multiple coming out of Valens. So you'll see one in hash , you'll see one with live resins, and then you'll see one with distillate. But not only will you see a branded one. You'll see some B2B partnerships start to leak out in some of those verticals as well. And I'll tell again from the last call, our B2C relationships are stronger than ever, and you'll see some of those. So obviously, you saw the 6 relationships go public. You're going to see a few more coming very, very soon.

For now, I'll turn the call over to Jeff Fallows, President of The Valens Company, to dive into deeper operational achievements and strategic initiatives.

Thanks, Tyler. We are very pleased with the progress we have made on our strategic initiatives and have taken some tough but needed first steps to transform Valens into a leading cannabis consumer and packaged good company. In the third quarter, we experienced strong growth in product sales on a sequential and year-over-year basis, resulting in a 20% increase in net provincial sales and a 76.5% increase in consumption level retail sales according to Hifyre. I highlight this growth in provincial sales in the midst of a tough market backdrop, not to suggest we are satisfied with the top line revenue performance in the quarter, but as a clear indication that the mechanisms or the mechanics of our previously discussed strategic plan, including differentiated launch, grow and optimize phases, is working and has only just started to produce the results we envisioned at the outset.

Our launch phase has generated deep and broad SKU penetration at the provincial level with our provincial listings increasing by 37.1% to 181 in Q3 2021 compared to 132 in the second quarter. 27 additional provincial listings were achieved since the end of Q3 2021 and another 40 provincial listings will be added from the acquisition of Citizen Stash amounting to pro forma 248 provincial listings. We believe this industry-leading growth has successfully set the stage for the next phase in our strategic plan, the growth phase, in which we intend to target accelerated expansion of market share, strong revenue growth and margin improvement.

As we enter this phase, we have already initiated both process and operational changes to ensure we are able to efficiently service the anticipated increase in demand. In addition, we have repositioned our B2B business to focus on deeper relationships with larger partners, and we'll be making targeted investments in the automated equipment to handle both the growth in volumes and support a key growth rate objective and increase in margins. We anticipate the benefits from these and other activities will be realized over much of the 2022 fiscal year before we turn our focus to the final step in our strategic plan, the optimization phase.

Touching on our U.S. strategy and Green Roads, with slightly more than 2 months of revenue accounted for during the third quarter of 2021 and revenue contribution of $4.7 million, we believe the U.S. CBD segment will be a long-term growth engine for Valens. Going forward, we will remain focused on executing and leveraging both our relationships and manufacturing expertise to drive both channel and volume growth for new and existing Green Roads products in the U.S., Canada and internationally.

We've witnessed the remarkable demand and popularity for products across the CBD and cannabinoid-based,wellness space and are fortunate to have gained a piece of this significant market. While our top priority remains building our Canadian and U.S. domestic footprint, we continue to make capital and asset-light strategic advances to expand our international opportunities. Indicative of this strategy, we recently entered into a long-term partnership with Australia's Epsilon Healthcare Limited.

This exclusive manufacturing partnership will give Valens the access to Epsilon's Good Manufacturing Practices, or GMP, facility in Australia. The key benefit of this partnership will be to accelerate our growth in Australia while also giving us access to EU GMP-grade products for export to key international markets, such as Latin America, Europe, the U.K. and the Asia-Pacific region. Entering this partnership with Epsilon is another milestone for Valens and delivers on a key and promise deliverable in 2021.

The agreement also reaffirms Valens' positioning as a leading global CPG cannabis manufacturer. Additionally, we continue to advance the Pommies facility in the GTA as we anticipate receiving Health Canada's approval to begin manufacturing and distributing our Cannabis 2.0 and 3.0 products in the near term. We continuously strive to grow our distribution network in order to meet the market demand across Canada, and Valens currently manufactures products to serve 6 provinces and 1 territory. During the third quarter, we made significant progress in our efforts to bring our innovative product portfolio to Quebec, a key market that represents nearly 15% of Canadian cannabis retail sales.

Specifically, Valens has received authorization from AMP to contract and subcontract with a public body in Quebec. AMP's authorization has set in motion Valens' ability to become a registered vendor to supply goods and services in Quebec. We have consistently messaged since the beginning of the year that Valens would exit 2021 as a very different company than when we entered. Implicit in that assertion was our belief that at the end of the year we would be best positioned to service both our customers and consumers, grow market share, drive towards profitability and be a leader in the industry. We believe Valens is poised to enter 2022 from a position of strength with a balance sheet that allows us to operate in a nimble manner in order to capitalize on future M&A opportunities and organic growth. The future prospects for Valens have never been better, and we are excited about the opportunities that lie ahead, both for the company and our shareholders.

I'll now turn the call over to Everett to discuss industry trends and capital market activities. Everett?

Thank you, Jeff. As Tyler and Jeff have made clear, we are a very different company than we were at the beginning of 2021. To illustrate this, I want to start with 5 quick facts that we believe only scratches the surface on putting into context the transformation Valens has undergone.

One, roughly 50% of our sales in Q3 2021 were made up of U.S. CBD and Canadian provincial sales where both segments were largely nonexistent last year. Two, Valens owns Green Roads, a top 10 U.S. CBD brand, which has shipped over 10,000 locations and has a robust e-commerce business, whereas, at the start of this year, Valens did not have any U.S. operations. Three, we have now shipped well over 1 million units to 7 provinces and territories in 2021, showing the power of our team and our platform where last year we only manufactured hundreds of thousands of units and shipped to 4 provinces. Four, edible provincial listings made up roughly 25% of our overall listings at the end of the quarter where we had 0 at the beginning of the year.

Five, Valens successfully launched the top 5 dried cannabis SKU with Verse without cultivating cannabis where a year ago this wasn't even a product category we operated in. We believe our joint B2C and B2B platform that mirrors large CPG companies offers a unique opportunity for investors to gain access to higher-margin branded products and increased utilization manufacturing for third parties while leveraging the sophisticated platform we have built today. The edibles category is going to continue to be a focus for us as seen by the innovation products that we have launched across the category, including Very Cherry Chocolate covered gummies, Vacay Ice Cream Sandwich cookies and cream chocolates bites, and the Chocolate Peanut Butter Cup, just to name a few.

In Canada, the edibles category is one of the fastest growing, having increased retail sales 123% since Q3 2020 and now represents 5.1% of the market as of Q3 2021 in Alberta, Ontario and BC according to Hifyre. With our recently announced agreement to acquire Citizen Stash and acquisition of Verse, we have gained exposure to a much larger share of the market, operating in 2 of the best segments for profitable growth, Cannabis 2.0 products and premium dried flower. In Canada, today, extract-based products make up approximately 30% of the sales compared to California, a more sophisticated cannabis market, where they make up almost 50% of sales. This growth is also illustrated in premium cannabis with the Canadian premium cannabis making up 14% of the market, where in California, this makes up 31% of the market today.

We believe that California is a great road map for the future growth. And upon closing these 2 acquisitions, we believe we have 2 brands that are well positioned with leading provincial listings and market share. Furthermore, the pending strategic acquisition of Citizen Stash is expected to provide accelerated entry into the premium flower vertical with an asset-light approach. Citizen Stash is a world-class genetics company that will bring to balance a network of contract growers that is a very similar model to other CPG industries interacting with agriculture. Citizen Stash is expected to bring 40-plus provincial listings to our platform, increasing our pro forma provincial listings to 248.

Valens is now present in 7 provinces and territories, and this will grow to 9 across Canada, assuming the successful close of the Citizen Stash acquisition. Additionally, our acquisition of Verse, which closed subsequent to the quarter with the natural progression of our active partnership, which has allowed Valens' full access to its broad product portfolio offered across the Cannabis 1.0 and 2.0 categories. We view this acquisition of Verse and the pending acquisition of Citizen Stash, once completed, to strongly position Valens branded products across the value chain and showcases Valens' low-cost manufacturing platform. We anticipate both acquisitions to be accretive to Valens.

We have remained focused on finding strategic M&A opportunities that would complement our longer-term vision. With the U.S. being at the top of our list, we are working to provide our shareholders with greater exposure to this massive market in a variety of strategic verticals. In addition, we are constantly monitoring the Canadian and international markets for growth and synergies.

Alongside all of these achievements and as we've recently announced, despite a longer-than-expected time line due to the backlog as a result of the pandemic, we are diligently pursuing the process of completing our listing on NASDAQ and anticipate we will commence trading on the exchange before the end of the year. The NASDAQ listing is expected to provide balance with greater trading liquidity while also allowing for a broader base of institutional investors.

With that, I'll now turn the call over to Sunil to run through the financial results for the third quarter of fiscal 2021.

Thanks, Everett. Now moving on to our third quarter 2021 financial results. Net revenue increased by 15.8% to $21 million for the 3 months ended August 31, 2021, compared to $18.1 million in the same period of fiscal 2020. The increase in revenue was primarily driven by cannabis operations revenue and more specifically by an increase of $4.5 million or 29.7% in product sales. Offsetting this increase was the continued decline in revenue associated with total traction, co-packaging services and bulk oil sales, as the company continues to execute on its strategy of transitioning away from a focus on toll processing to a product development and manufacturing company.

Gross profit margins for the third quarter were 26.8% compared to 22% in the second quarter of 2021. The improved gross margin in our most recent quarter compared to the previous quarter was mainly attributable to the higher margin profile in the Green Roads business. The margins in the Canadian business continued to perform below our long-term expectations due to the inherent inefficiencies of new production processes, especially those associated with new product launches. In addition, throughout the last year, Valens has experienced supply chain challenges and chronic labor shortages in the market, which ultimately drive up labor costs.

It is expected though that gross profit will continue to improve over time as we optimize our product mix, production volumes increase and processes are made more efficient through automation initiatives. Operating expenses were $19.5 million compared to $15 million in the second quarter of 2021 and $10.7 million in the same period last year. The increase in operating expenses compared to the previous quarter is predominantly due to the inclusion of the Green Roads business, along with increased D&O insurance costs covering our U.S. operations serving as a secondary factor, and all other remaining expenses actually coming in slightly lower than the previous quarter.

Valens ended the third quarter 2021 with an adjusted EBITDA of negative $6.2 million compared to negative $5 million for the quarter ended May 31, as the increased revenues and gross margins were offset by higher operating expenses. We do remain confident that our transition to a global product development and manufacturing platform and our acquisitions of Verse Cannabis and the completion of the pending Citizen Stash acquisition will result in positive performance in the coming quarter.

We are looking forward to the fourth quarter 2021 and fiscal 2022, where we anticipate an increase to recurring lines of revenue as a result of our focus on capturing additional market share and increasing our listing base. The company will continue to leverage our updated business model as well as the pipeline of new partnerships, accretive potential acquisitions and global expansion opportunities to create substantial value for all shareholders and stakeholders.

From a balance sheet perspective, Valens continues to manage its working capital balances to ensure a strong balance sheet position. As of August 31, 2021, overall receivables on the balance sheet were $41.1 million, which included $34.5 million of trade receivables from customers with the balances being made up of other non-trade receivables. The balance of trade receivables as of August 31 actually declined by 9% from the balance outstanding at the end of the previous quarter, with the inclusion of receivables from Green Road serving as a partial offset.

In addition, Valens has subsequently collected and has a trade accounts payable outstanding with the same partners representing 68% of the total accounts receivable balance, which is outstanding as of August 31, 2021. As the revenue mix continues to move towards increased sales with provincial and B2C customers with more regimented and favorable payment terms relative to B2B LP customers, we do anticipate continued improvements in the amount of outstanding in Europe.

From an inventory standpoint, the company has $29.6 million on hand as of August 31, 2021, compared to $15.2 million on hand as of May 31, 2021. The increase in inventory was largely driven by 2 main variables: one, being the need to procure and double the inventory in advance of the numerous new product launches that are being undertaken; and secondly, there was an operational need to build more finished goods inventory to more effectively service our key provincial customers with growing volumes and demand for our various products.

This can be demonstrated by the $5 million increase in the company's finished goods position as at August 31 compared to the previous quarter. The cycle of new product launches and changes in product mix can be expected to cause the near-term volatility in inventory balances in the quarters ahead, but should be expected to stabilize once customer demand and sales patterns achieve a more normalized and rhythmic state.

Valens ended the quarter with a strong cash position of $31 million as of August 31, 2021, compared to $23.9 million in the previous quarter. There was a significant amount of capital flows within the quarter, starting with the $43 million capital raise at the beginning of the quarter. This was then offset -- partially offset, I should say, by the proceeds of approximately $18 million, in part to close the acquisition of Green Roads.

In addition to the settlement of various transactional costs, capital spend, debt repayment and the full payment of our full year premium on the company's D&O insurance policy associated with entering the U.S. market. The total of all the above items resulted in the use of $28 million in cash. And then the increase in inventory levels of $14.4 million to support operational requirements was partially offset by the decline in trade receivables and the recent improvements in the operational cash burn rate. With these items largely behind us, we feel good about the strength of the company's balance sheet and cash position as we enter the fourth quarter.

With that, I will turn the call over to the operator to open the line for the question-and-answer session.

(Operator Instructions) Our first question comes from the line of Andrew Partheniou with Stifel.

Maybe just to start off on Quebec. Could you provide an update on the process? What -- and what do you think needs to be done in order to become an approved vendor? And once you do become an approved vendor, could you walk us through, if possible, on how [protocols] work in the province to ultimately have your brands and products on the shelf?

Yes, absolutely. Thank you, Andrew, for the question. Obviously, it's Tyler. A few different things here. One, Quebec is definitely a challenging market, especially with the change in management, with the new CEO coming in relatively soon. And I think I'll call it October 22 is his new start date. There's just been a few challenges and changes and may slow down a few things as we continue, but we're still super excited and extremely confident that we will be in Quebec in a meaningful way in the near future. Obviously, with some of the challenges of changing management, you change relationships, you change ideas, you change strategy. But I'll echo again we are confident that we will have a meaningful position in Quebec. We are working on an agreement. It is well underway. I probably won't comment further on when we're going to have it done, but it is in the near future, and we are excited.

Definitely looking forward to seeing your products in my own province. Maybe switching gears talking about gross margin improvement. I think you mentioned the driver in this quarter was mostly CBD. Could you talk a little bit about your facility utilization rate, where it stands now? You have a lot of SKU listings that you've won and lot of new brand partnerships that you've announced and obviously pushing on your own brands as well going forward. So how can we see that utilization rate ramp up?

What do you think that could do to gross margins? And maybe tying that in with -- you make a comment earlier on the difference between listings -- SKU listings and SKUs manufactured. Can see here that your listings are almost double the rate of the SKUs that you're manufacturing, which could potentially be a leading indicator for your gross margin. So a lot of moving parts here. If you could just touch on that and what we can expect going forward?

Yes, absolutely. So obviously, a lot to unwind in that one. I'll start with kind of K2. As we continue to ramp up, it's hard to pinpoint an exact number on where we are, especially with some automation still coming online. And like I touched on earlier, we expected to have some of it online earlier, to be frank, and again, some of the challenges of not only getting it commissioned or validated but getting physical packs in primarily to bring on some of that stuff. So I don't think I can pinpoint an exact number, but what we will see is less manpower and more automation. And that's one of our key focus is to drive gross margin. And in time, you will obviously see it continue to get better and better and improve over time. Yes, I think that's basically the best way to say it. Jeff, anything?

And I think if you think about it -- and I like the distinction between the number of SKUs and the listings. Obviously, we believe the listings are a leading indicator of future revenue potential. And what we've done in the last quarter is focus on getting all of those products available or the processes available to handle the volume growth that we're anticipating. So think about when you scale up to sort of process, there's lots of inefficiencies. There's lots of learnings. There's lots of things like that, that go directly against our gross margin. Those things largely being worked out and as the volumes start to increase and those provincial orders start to increase -- like your first orders are always small,right, Andrew? And then the second order , the third order and fourth order. So as those orders continue to increase and you get the real benefit of launching those products, there's a natural progression that the gross margin increases.

Fantastic. And just a last one, if I could. Just on the cash burn, SG&A, Sunil, thank for that good color there. Obviously, on the SG&A line, we saw it increase quarter-over-quarter, and this is above -- well above the Q1 levels here. Could you -- with the color that you provided on the insurance payments and closing of acquisitions, could you provide a little bit of color on what we could expect maybe in Q4? Should this stabilize out? Should we even perhaps expect a decrease in expenses here? Just a little bit more color on that could be helpful.

So I think I'll start by saying I think the most material change from the previous quarter was obviously now including Green Roads as a business into our numbers, right? Otherwise, if you actually look at Q3 versus Q2, our SG&A line was actually very, very stable. So now it's taking to account Green Roads being part of our business going forward, and the D&O costs also being part of our business going forward. I can't tell you exactly where SG&A would line up next quarter, but I'm not expecting material changes from where we are right now.

Our next question comes from the line of Frederico Gomes with ATB Capital Markets.

So just to start off, about your U.S. CBD segment, could you comment on the competitive landscape there? What are you seeing in terms of pricing and just overall growth in the industry? It's a very fragmented market there. And how confident are you about reaching the EBITDA targets that you set for Green Roads for 2022?

Yes. Great. Thanks for the question. So in the CBD space, obviously, when you look at -- and you said it's fragmented, and we're starting to see some consolidation, some of the smaller players sort of fall away out of the space as the users and the consumers of CBD in the market begin to get a little bit more discerning about the products that they're utilizing, we like that trend, and we like the opportunity that, that provides to Green Roads. As we continue to move forward, there's a couple of tailwinds that it would, in our view, greatly propel the opportunity that we're seeing in the CBD space down there. Obviously, the first is getting a little bit more clarity from the FDA. As you would know, when you look in the store formats, et cetera, carrying various CBD products and the assortment of products that are available in some of the larger format stores very limited right now given the FDA uncertainty, really limited to sort of topicals, et cetera, in those distribution channels.

So getting some clarity there would be a nice tailwind for us. And as you're saying in -- from that -- the EBITDA targets or the opportunity we saw in Green Roads would be -- go a long way to fulfilling that objective that we have. That's sort of one catalyst alone. Otherwise, as we're bringing the 2 businesses together and we're consolidating relationships and making introductions for Green Roads to balance relationships, as we I told the market we were going to do and also compare product assortments and IP opportunities, opportunities to share IP, et cetera, we're pretty excited about what we're seeing out of Green Roads. We're excited about the team that's down there and what they're doing for us. So while it's -- I think it's too early to comment any more on sort of that EBITDA number that we announced for the acquisition, we are greatly encouraged by what we're seeing, and we still very much like that opportunity.

Yes. So that's great color. And maybe just on your outlook here. We know that Q4 is still going to be a transitional quarter for you guys. But just looking forward into 2022, how should we look at growth? Will it come more from your B2C side, 2.0 products or 1.0 products or maybe from Green Roads or even internationally? Or how should we look at that in terms of a mix between B2C, B2B and Green Roads and international?

Yes, absolutely. So I think what you're going to see is all of the above with a major focus on B2C, not only in Canada and the U.S. As we move towards the B2C model and really get behind some of the brands and open up distribution, I think that's going to be one of the biggest growth factors that you will see in 2022.

Yes. And obviously, as Tyler said, the strong emphasis, our expectation there on the B2C side, but not to underplay what we're seeing from the B2B side and the opportunity that we're seeing there. We continue to like the relationships that we have and that we're building and think that there's very strong potential for our base business in those relationships. And as we look south of the border and we look to Green Roads, again, the pipeline of opportunity that we see there, the conversations that are currently ongoing and the general market backdrop of several catalysts as we just discussed for CBD space, we're very encouraged about what the contribution that Green Roads can be making to balance financial statements in 2022.

And Frederico, it's Everett here. Maybe to further kind of give context to that, and you saw this quarter that we had 50% of our sales coming from provincial sales and Green Roads already. Now with the closing of Citizen Stash, I think you see that aspect greatly increase going into 2022. So that's great context for you from a modeling standpoint where, obviously, we picked Citizen Stash in the 2.0 areas because they're not only the fastest growing, but we see long term the best profitable growth in those 2 categories.

Our next question comes from the line of Shaan Mir with Canaccord Genuity.

So my first question, I just wanted to touch on where the business is at with the SKU optimization. In the press release, it was noted that Valens reached critical mass on the SKU portfolio this quarter. And I think earlier in the prepared remarks, I believe Tyler mentioned that there was some additional opportunity to move away from underperforming SKUs and what's being distributed today. So I just wanted to calibrate what portion of the currently listed SKUs do you see opportunity to drop? And then also as it relates to the Citizen Stash portfolio, what portion of that business' current distribution do you see opportunity to take offline or optimize on that front?

Yes. But maybe I'll start with Citizen Stash. As we move closer to closing that transaction, I think there is a good opportunity to, again, optimize their portfolio and really bring them into the fewer, bigger, better strategy and really bring velocity some of the SKUs -- the SKUs and sort of automate their packaging. Right now, they're doing everything by hand. And the way they're sourcing biomass is not efficient, if you know what I mean. So bringing the fewer, bigger, better model to them, I think, will greatly improve their gross margin as we incorporate it. Also, when you look at our SKUs, what you'll see over the next kind of couple of quarters -- and again, it takes longer than people think it does to even delist the SKU or list the SKU with the provincial board. So you'll see us move on some of our smaller partnerships or our non-velocity SKUs and really double down.

And one thing that has greatly affected our velocity or even optimization is our provincial sales are selling so quick. We can't keep up with the demand. So it's negatively impacting our gross margin short term, as we continue to throw bodies at it, where we lack automation. So there's some processes right now where you look at we have 10 manual people packaging things out that are going to go to 1 machine. So it's greatly going to affect our -- not only our output but our gross margin. So there are a few SKUs we're really getting behind .You look at BC God Bud, you look at the first pre-rolls and then you look at our bev category, you're going to see greater velocity and more automation coming out of those.

And then my second question. It's more on the international front. Could you help outline some of the capital requirements with the Epsilon Southport agreement? My understanding is that Valens assumes the operational and capital expenditures at the facility. So just curious what's remaining from a CapEx perspective and then what the expectations are for CapEx spend over the next year?

Sure. So first of all, let's address sort of the opportunity in Australia. So out of the gate, we don't anticipate any significant capital investments into the facility at all. Right now, it's an operating platform. It already has the capability of producing products and, in fact, it's producing products for Valens already today. The potential for CapEx goes forward as the market continues to develop there.

And as we've always said, once the economic opportunity proves itself, we'd be more than happy to put capital to work. So as we continue to build out that business, once it gets to capacity and once we start to see the opportunity continue to increase for us there, we won't be shy about making some additional investments and -- into that market. But to be clear, that's not a big swing capital investment. That's some additional equipment. That may be upgrading some additional -- or some of the equipment they have down there. So it's not a big swing. It's right-sized capital investment, but it's only when we see the economic opportunity to earn a return.

Our next question comes from the line of John Chu with Desjardins Capital Markets.

So you've put the strategic transition mostly behind you now. You're in your growth or a ramp-up stage. So is it safe to say that the third quarter and even the quarter prior to that, the second quarter, is really your trough or your bottom? And that going forward, we should start to see accelerated sales with that gross margin improving? And then, obviously, the EBITDA starting to improve from these levels going forward. Is that a fair statement?

Yes. I think it's a fair statement, John. The question becomes just a matter of timing on that. So when you're launching a SKU, just to be clear, as Tyler said, it's a long process, which is when we announce them to the market, all these SKUs that were getting listed and noting the listings, we don't want to be judged necessarily on our listings. What we're trying to do is be clear with the progress that we're making with the strategic plan to actually get to the larger scale revenue that those SKU listings represent. Could be anywhere from 6 to 12 months, right?

So as the province access the listing, brings it on, you meet the first delivery opportunity to the province, they do their initial orders and then it gets into the system. And through the system and you start to get that velocity, it could be anywhere from 6 to 12 months. So yes, it's 100%. Getting those listings in was a big first step. We're very excited about that, and we are going to be working with the provinces to drive that volume as quickly as possible. But just to set realistic expectations out there as to what that means from a growth and a margin profile perspective, yes, it's coming. It will just be product dependent and it will be over the next 6 to 12 months.

Okay. So then maybe adding on to that. So your manufactured SKUs -- I guess, a few quarters ago you were in the low 60s. You dipped into the low to mid-50s. And now you've jumped back up to 67 as of the third quarter. So it sounds like those 10 new additional manufacturer SKUs from the prior quarter, that sounds like it's going to be a drag on margins then for the near term, similar to the idea you had before that the revenue -- that you're going to have a higher cost structure and then it's going to take a bit for the revenue to catch up. So is that going to act as a bit of a margin headwind, even though you have your listings starting to ramp up revenue?

I'd say yes and no. I'd say, yes, when we start something, there is additional cost profiles we've been trying to be clear about with the market. But look, additional SKU listings are variations of existing SKUs. So they're not all new SKUs, for example. So variations on pre-roll formats or putting -- whether you do 5 in a pack or 10 in a pack or something like that, these represent additional SKUs, John. But they don't necessarily have the same kind of impact as when you're launching a new product line.

So the 67 manufacturers SKUs, they're not...

[It's not].

Okay.

Yes. Exactly. So they're not wholesale new product forms. They're based on existing processes and variations that we're adding to those. So from an efficiency perspective, there's much more -- or there's much less hit on cost, even though we believe that there's real opportunity for those SKUs in the market from a revenue perspective. So not nearly as pronounced as historically when we were launching all new product forms.

Okay. So those 10 additional quarter-over-quarter in manufacturer SKUs, could all of them are essentially derivatives of existing SKUs?

Correct. Correct.

Okay. Perfect. And then just the last question then. You talked about -- or Tyler talked about some supply chain issues, just delayed equipment and getting technicians over and whatnot. Did that have a meaningful impact on sales for the quarter or margins? And have those issues been resolved yet?

Yes. I would say overall sales -- if you look at what we could have done in the Verse pre-roll, for example, we can't meet the demand. And if you look at like even the labeling of that skin, we're doing it by hand as compared to automation. So it affects margin and it effects velocity of SKU. So I think both of those come in. And again, I think people are underestimating some of the global supply chain issue. There's absolutely nothing we can do. And some of the automation is on route. It's been delayed a couple of weeks, some cases a couple of months. But again, we're not going to risk putting inferior product on the shelf to damage the reputation and/or brand. So if it's -- we're the product of the environment essentially. But yes, we did leave some money on the table and it did affect our gross margin. So we will clean that up, and we're extremely excited to get those products and processes online.

So is that going to be still a modest drag in Q4 then?

Yes.

Our next question comes from the line of Neal Gilmer with Haywood Securities.

I'll probably just sort of continue along the line of the listings here to understand that. And then a second question after that. You obviously had a 37% increase in the listings that you put in and then subsequent to that some more. What's sort of driving the success to be able to get those provincial listings? And then sort of the subpart to that question would be if you take, for example, the 6 manufacturing agreements you recently announced, are those already listings that you have with the provinces? Or those are net new listings that we should expect as you start to manufacture those products and get them into the provinces?

Yes, so thanks for the question, Neal. I'll touch on the provincial success first, why are we winning provincial listings. I think it's kind of 3-prongs. One, innovation. I don't think some of the products going live anyone else can do. You look at a peanut butter cup. You look at a few of the other edible innovations we've got listed. You look at the hard seltzers that are going live in a can with a resealable lid. We have innovation that no one else can touch. Two, the product offering, the depth of product where it's basically where -- I don't want to call it bartering and trading with some of the provinces like look, we'll do that for you if you guys give us these 2 products. So it's really about the relationships we have in place and really being seen as an ally to the provincial board.

Other than that, I think we would see pricing as the lowest cost producer or the largest purchaser of biomass and the lowest cost producer for bulk biomass. I think we can do a product offering that no one else can touch on the price. And as we continue to bring on automation and optimize a lot of the processes, you'll really see that gross margin start to improve. The second question, with those sticks agreement that we went live with, some of them are to provincial boards and some of them are strictly bulk back to the licensed producers with excess capacity we have. So when you really look at utilization of infrastructure, that's where we really start to move the needle as well as backfilling our excess capacity.

Okay. Appreciate that. My second question sort of comes back to, I guess, the strategy. Obviously, this has been a transformative year, and you've had a number of acquisitions. As we look forward now, is your strategy sort of focused on integration and demonstrating how accretive those acquisitions are and making sure that everything goes well with respect to the acquisitions? Or are we to be expecting -- still you're very aggressive taking a look at potential opportunities and could have some further acquisitions over the course of the next, say, 12 months or whatever?

I would say the biggest thing getting our attention right now is going to be integration, but also supply chain. When you look at the ecosystems that we bought -- and I'll use Citizen Stash with a pending transaction coming. You look at the ability for us to move the needle, not only on the supply chain standpoint and really get to automation, even like, again, sourcing biomass at a significantly deep discount to what they're currently paying. I really think integration and supply chain are going to be the story of Valens going forward. Obviously, we're going to be opportunistic if the right opportunity comes along. But the story for us is going to be integration and supply chain on all those acquisitions that we've made.

Our next question comes from the line of Gerald Pascarelli with Cowen.

So my first one is on Green Roads. Obviously, a nice contributor to your top line this quarter, even though it was a partial quarter. I'm just curious if you could provide any color on how sales are maybe trending into your fiscal 4Q. And then the expected benefit that you expect Green Roads to get following the passage of AB45 in California. It seems like obviously a net positive for the industry just in terms of distribution white space. So any color you could provide there would be helpful.

Yes. Thanks for the question. So from a Green Roads perspective and a revenue perspective going into the fourth quarter, I would expect in the short term the company to continue to operate as it has on a similar basis to what it did in the third quarter as we're going through and making introductions and also driving through some -- The Valens added value to the equation. It takes time to get that stuff properly implemented and get out into the market.

So I would expect the bigger changes or the more growth to happen going into 2022 down to Green Roads. But that being said, as I said earlier, there are some potential positive catalysts south of the border there that could change that equation dramatically. California is an interesting opportunity. And from Green Roads perspective, where there wasn't significant sales into California, obviously, given the previous regulatory state there, but on the back of that opening up, absolutely, that's an opportunity for Green Roads and one that we're going to be helping them realize in the coming weeks and months there.

Got it. That's helpful. My next question is on your partnerships. I know that you had called out in the press release that you're transitioning away from your smaller, nonprofitable B2B partners, which obviously impacted your revenues. But at the same time, you signed a big custom manufacturing agreement with 6 larger customers. And so I guess, like as we look at the business going forward, is that disruption from the transition behind us should this new manufacturing agreement at a minimum partially or if not fully offset some of the disruption that you're seeing currently in your revenue trends? Any commentary there would be helpful.

Sure. Thanks, Gerald. It's a great question. So if you look at the transition of that business, those 6 agreements are projected to ramp up over the next 2 quarters. So yes, I think it was the right decision to go away from underperforming partners, right? What you want is more profitable growth. And what we try to do with these larger partners is we want more consistency from them. And we want that relationship of higher utilization, higher volumes, and that's what we've gotten. Of those 6 partnerships, 3 of them were the top 7 LPs in Canada. And as Tyler mentioned, I think you continue to see that to grow over the next term. So I think you see that ramp up over the next 2 quarters because some of the agreements don't start until Q1, Gerald. But largely, you're seeing that transition over that, and, obviously, that transition of B2B going to more consistent and larger players.

Yes. And one thing I'll kind of add on to that is out of those 6 agreements that did go live, all of those were Canadian-based groups. What you'll see in the upcoming weeks, month, quarters is some U.S. partnerships. Again, the same relationship we have in Canada. We're going to be taking them and/or joining them in the U.S., which you will see go live in the foreseeable future. So fewer, bigger, better, both sides of the border.

There are no further questions in the queue. I'd like to hand the call back to Tyler Robson for closing remarks.

Thank you, operator, and thank you for everyone joining. Obviously, not the ideal quarter and again we're not shying away from it. There are headwinds in the sector, and we're doing our best. And if you look at the achievements we've made, not only internally, but in comparison to some of our peers, we are winning. We are confident and we know exactly what we're doing. Is it going as fast as it should? No, it never does. But at the end of the day, we are getting better every single day. Underlying fundamentals are clear and it's coming to fruition in all products, in all verticals. Momentum is fueling our growth and will continue at the end of the year, into 2022, unique and innovative products going global, increasing provincial listings and delivering sustainable value to our shareholders. I want to say thank you for all the support. And with that, I'll turn it back to the operator to close the call. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.