KushCo Holdings Inc. (OTCQB:KSHB) Q4 2018 Earnings Conference Call November 26, 2018 4:30 PM ET
Executives
Phil Carlson – Managing Director, KCSA
Nick Kovacevich – Chairman and CEO
Jim McCormick – COO
Analysts
Vivien Azer – Cowen
Paul Penney – Northland Capital
Alan Brochstein – 420 Investor
Mitch Baruchowitz – Merida Capital Partners
Operator
Good day and welcome to the KushCo Holdings Fiscal Year 2018 Earnings Results Call. Today’s conference is being recorded.
At this time, I’d like to turn the conference over to Mr. Phil Carlson. Please go ahead, sir.
Phil Carlson
Thank you. Good afternoon and welcome to KushCo Holdings fiscal year end 2018 financial results conference call. A replay of this call will be archived on the Investor Relations section of the KushCo Holdings website; ir.kushco.com.
Before we begin, please let me remind you that during the course of this conference call, KushCo management may make forward-looking statements. These forward-looking statements are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations.
These risks are outlined in the Risk Factors section of our SEC filings. Any forward-looking statements should be considered in light of these factors. Please also note, as a Safe Harbor, any outlook we present is as of today and management does not undertake any obligation to revise any forward-looking statements in the future.
With me on the call today are Mr. Nick Kovacevich, KushCo Holdings’ Chairman and Chief Executive Officer; and Mr. Jim McCormick, KushCo’s, Chief Operating Officer.
With that, I would now like to hand the call over to Nick. Nick, please go ahead.
Nick Kovacevich
Thank you, Phil, and thank you to everyone who has joined our call today to discuss the results of our fiscal year ending 2018. Throughout fiscal 2018, we’ve continued to demonstrate dramatic growth in our most critical markets. It’s growing customer number and increasingly diversified product offering, a standard facility capability as well as the global presence anchored by our recently opened offices in Canada and China.
I will be discussing these events in greater detail as well as providing background on how each event set us up for continued success as the market grows, both domestically and internationally. First, I would like to quickly run through a high level recap of our top line results. We’re exceptionally pleased with the financial results we achieved during the fiscal year. Revenues were $52.1 million, representing a 177% growth compared to approximately $18.8 million in fiscal 2017.
This includes the record fourth quarter of almost $20 million, which is greater than all of our full year revenue for 2017 and represents a 55% increase over our Q3 2018 numbers. Of the 52.1 million in total annual sales approximately 50 million is attributed to organic growth. These strong top line revenue numbers were the result of several positive trends within the business, including greater customer numbers, increased spending per customer, effective cross-selling as well as continued geographic expansion and broader product offerings.
We continue to establish greater market share by executing our organic growth strategy, developing and maintaining key relationship with the leading brands and large multistate operators. As we introduced new product offerings, these relationships allow us to effectively cross-sell and achieve more revenue per customer within our key customer population. As we continue to achieve scale while offering more relevant products to our existing market, this allows us to become stickier with our existing customer base. And by using our first mover advantage in new emerging markets, we are also able to effectively grow our new customer base too.
We believe that we’ll be able to build on our momentum and accomplish our goal of becoming the premier ancillary provider of the legal cannabis sector. Over the past year we have transformed our business model, we started out as a provider of customizable packaging solutions to the cannabis industry and we’re now operating a diverse group of business units that are transformative leaders across several categories. This dramatic expansion of services and products has enabled us to enter new markets and to reach a significantly wider customer base.
We’re pleased to report that we have significantly outgrown the market in each state in relation to the growth of the industry as you can see on Page 2 of our supplemental earnings slide. As a point of reference Statista, which is a leading cannabis market research provider has projected the following overall cannabis growth rates for 2018 California 50%, Washington 31%, Colorado 25%, Nevada a 131% and Oregon 30%.
As you can see on the chart, our growth has significantly outpaced the growth numbers that were just provided. In some of the most interesting numbers to call out is our growth in California, which was almost 220%, again the market data shows that market growing at about 50%, so we’re over four times the normal growth rate in California which remains one of our strongest markets and of course our home market in which we started the business. We believe there’s still significant upside in the California market as the regulations are just now getting developed and rolled out, and the black market is overtime getting shut down.
Some other numbers to call out is our impressive growth in Washington and Colorado, Washington at 93%, Colorado at a 110%. These are in the two oldest, most matured and established markets with the slowest growth rate. We’re growing at almost three times with the market is growing in these markets. And then lastly, where we see significant upside is in the Northeastern Canada. These are new markets which, as of the close of our fiscal year had not even completed one sale of recreational cannabis neither in Massachusetts nor Canada yet we’re seeing growth rates near a 1000% in the Northeast and in Canada of 750%, and we can only expect those growth rates to continue in those markets.
So as you can see our growth rate has exceeded each states performance and our overall growth rate in states with legal adult-use sales was a 181% year-over-year. More details can be reviewed on Page 2 of our supplemental earnings slides, which are up in the events page of our investor website. From a revenue standpoint, we think about our customer base in five categories and we included a detailed breakdown of our revenue mix and growth rates on Page 3 of our supplemental earnings call slides.
The five name products buckets are Vape Packaging; Paper & Supplies; Energy and Natural Products; and Labels, Seals and Applications. Looking at our revenue by product categories, Vape continues to form a majority of our revenue at 53% of revenues for 2018 and by acquisition of Summit in our Energy and Natural Products category contributed to 8% of our Q4 revenue.
Something to call out of this chart is that again our business has been traditionally known as a packaging business when really less than 30% of our overall sales can be attributed to the packaging category. What we really like about this as well is that two of our highest margin categories the Energy and Natural Products and the Paper and Supplies category are relatively new and been able to offer robust offering. On the Energy and Natural Products, this is due to the Summit acquisition. And on the Paper and Supplies, this is due to an exclusive distribution deal that we’ve signed to actually get supply of some of these key paper products.
So, we expect these two higher margins buckets to be able to grow significantly while we’re also seeing growth in the other three buckets, but our goal is also to reduce the amount of percentage that Vape represents in our total sales, Vape out of all the five categories is our lowest margin bucket and it’s a goal of ours to be able to diversify out of that and expand into the higher margin categories while building the sensibilities across all five major buckets.
As previously mentioned, core pillar of our overall strategy is to establish strong relationships with our customers and become there reliable business partners supplying them with high quality products and services. We’ve made this a priority and are now regulators is servicing over 5,000 legally operating cannabis and CBD businesses across North America and abroad. Most importantly as a result of our diversified product offering and expansion in the new markets, we are now servicing larger customers who are not only buying more items from us they are also purchasing high value products which is driving the rapid acceleration of our revenue.
I’d like to turn your attention to the Page 3 in the supplemental earnings slides which provide a detail breakdown of customers by size. As you can see our largest customers are not spending the most on our products but they are also buying more classes of products compared to smaller customers. This truly is the testament to our successful cross-selling strategy which serves the backbone of our business model. Our largest customers segment which we define as customers that spend more than 500,000 annually spends on average almost a 1 million dollars per year with KushCo on an average buys 45 different product SKUs.
This is extremely exciting because if you look at the historical data in fiscal year 2016, we had zero customers to spend over half of million dollars, and here in fiscal ’18, we had 14 customers in this bucket and these are more exciting for those of you who follow the industry as most of these customers in this bucket are due to large multistate operators. And if you look at the growth plans that the customers have, they are extremely aggressive. And if these customers achieve anything near their growth plans, obviously, we’re going to significantly benefit from that as we were very strongly aligned with these customers we focus a lot of our resources on servicing them and we effectively cross sold them into a bunch of different categories so that these customers become more sticky in our platform.
We’re very pleased with the data showing that customers are spending more with us each year and the customers that are spending more also buying across our platform and buying more SKU, part of our one stop shop approach. Another key part of executing this strategy is making sure that we have the appropriate infrastructure to be able to support these larger customers as they continue to growth and expand in new market. Because of this, we’ve been investing significantly and building out our facilities to be able to support these larger customers. We’re currently maintaining five distribution centers in five of the largest cannabis markets in the U.S and we also have a local sales presence in every major U.S. and international cannabis market.
More recently, we have turned our attention to invest in infrastructure internationally, and in August, we initiated our international expansion with the establishment of a Kush Supply Co. Canada, our Canadian subsidiary, which consist of an office in Toronto and a national sales team focused exclusively on Canada. Kush Supply Co. services licensed producers in Canada with careful attention paid to the unique needs and regulatory framework of that pacific market. Our office in Canada is currently led by Gordon Woolley, who is the Vice President; and Mark Doerr, who serves as a Regional Sales Director. Both Mr. Woolley and Mr. Doerr have considerable experience in the Canadian market and have positioned the team to capitalize on the industry’s dramatic growth in the wake of Canada’s adult-use legalization, which occurred October 17, 2018.
In September, we opened an office in Ningbo, China, establishing a physical presence that helped us develop stronger manufacturer relationship and maintain consistent quality standard for customer needs globally. The office currently is run by Diana Malone, our Director Global Sourcing and Quality Control and houses four local office members who manage quality control inspections and new product development. Our staff on the ground ensures the proprietary products to maintain the strict quality standard we have previously established and allows us for seamless integration into a rapidly growing distribution platform. Our presence in China represents our dedication to the development of a robust, well-functioning supply chain that will position us for scalable growth in the future.
Another key pillar to building a long-term sensible business is our development and production of proprietary products which can be protected by patents and/or trademarks. Having a presence in China allows us to execute this strategy more efficiently and effectively. All we have experience a tremendous amount of growth over the past fiscal year; we would like to take a moment to expand upon some of the growing pains that we have experienced due to this growth. These pains include a net loss which was the result of the rapid increase in transaction volume and the sheer scope of products will move through the supply chain. Basically as our business started to ramp significantly, we did not have the proper processes and systems in place to be able to support that.
And as a result, we had to do some one-time write-downs inventory adjustment et cetera. We believe that this is a good problem, problem nonetheless the one that we’ve identified and now we put specific measures in place to be able to address and solve. As we solve this problem, it also allows us to implement more scalable processes assistance that will be able to allow us to accomplish our multiyear growth goals. So during the fiscal 2018, we posted net loss of roughly $10.2 million, which included a number of short-term costs, including the $2.8 million in inventory write-downs. While we’re disappointed with that this impact had on our margins, we believe there’re short-term consequences of our extremely rapid growth rate and we are pleased that we have already implemented several initiatives to improve margins on a go forward basis.
To give you an idea of our breakneck growth, sales for our best-selling 3 ounce jar grew 330% over three months last quarter. To fulfill, this extremely rapid increase in demand without allowing for any drop in customer service, we found additional suppliers for the product and air freighted the product in the U.S. from abroad to meet our customer deadlines. Since we elected not to raise prices on our customers, the increased costs hurt our gross margins. Additionally, our overseas supplier of pre-roll cones ran out of stock, once the adult-use Canadian market came online which impacted our supply chain and causes us to stake on further additional costs.
So in summary what we’re out here is the business that’s growing rapidly and that growth causes problem where we have to implement short-term fixes. These short-term fixes like hiring more people to do jobs the systems can do better. These short-term problems need fixes such as air shipping and product, it should be shipped over on a boat at a much affordable rate. We’re doing all of this because we need to solve the problems now and we need to keep our customers happy. We’re now looking at the profits that we’re generating off of our customers today. We’re looking at a lifetime value of that customer over a 10 or 20 year period. We know where these customers are going. We see their growth plans. We’re making the investments today even though it hurts our margins because we know that it’s going to payoff in the long-term.
And so as we fix these items, as we put in more sustainable scalable systems, as we get more scalable vendors and factories in place, we’re actually going to be able to recognize increased margins because again we’re keeping our product pricing the same. We’re selling at the same price where we’re today even though we’re incurring additional costs on the backend. Those costs are going to be short-term. We’re believe they’re going to go away as we get this thing piled in and then we’re going to have a highly profitable business at some point down the road.
So talking more about what we’re doing to fix these problems as a sustainable fix. First, we’ve engaged Manhattan Associates as our new warehouse management system provider. This is a very robust system and by implementing this new system we will be able to further sustain and expedite our rapid growth in an effective and reliable manner. In particular, it allows us to increase warehouse productivity, space utilization, inventory accuracy and compliance of internal processes. It’ll also provide the Company the ability to quickly adapt the planned and unexpected demand changes.
We did not previously have a robust inventory management system in place, and we believe this is extremely beneficial to the business now that we’re achieving scale. It’s the absolute appropriate time to implement this. Additionally, we have also engaged GoLeanSixSigma.com as consultants to build a new, stronger, scalable and sustainable process across the Company. These decisions will enable us to be more agile, and especially in our operations and thus with these improvements supplier-customer relationships will greatly benefit as well.
Now turning to accounts receivable, we’ve brought up 385,000 due to the regulatory transition in the California market, which changed on January 1st of this year, leading to our people in the marketplace that resulted in one-time costs to KushCo. Prior to January 1st, we’ve been dealing with dispensaries that following a change on regulation — change in regulation on January 1st, we’re no longer allowed to operate. We had to shift our entire customer base through the license growers and away from the centuries they were operating under the old preposition 215 model.
Some of our customers do not make their transition and as a result we had the right after counter receivable that were attributable to those clients. We believe this is a onetime event they resulted from that change in regulation in California. While these events have impacted our financials, I’d like to emphasize that they are in fast growing pains associated with the rapid growth they were seeing. Our business model remains strong and were confident that we have established and excellent platform to support both near and long-term growth.
We expect margins to gradually improve as we ramp-up our Kush Energy and Natural Products category as part of our overall plan to increase customer retention and sales. In the long-term, we believe we can improve margins without raising prices simply by leveraging all of the new systems we are putting in place. I’m happy that airship product not as these airship of products having a more robust supply chain with better inventory and management and better quality control. Together with our greater scale will allow us to benefit from economies of scale with the goal of obtaining 30% or greater gross margin.
Another important step that we have taken to support our operations as the larger company as to your point Christopher Tedford, as the Company’s new Chief Financial Officer. Part of the reason for this is to allow Jim McCormick, our Chief Operating Officer, who also serve as our Chief Financial Officer prior to Chris’ appointment to transition exclusively into the COO position to ensure the smooth running of our business as we expand our offering in the new markets. Chris brings considerable experience in the development of sound financial and operational policies. We expect to bring him on board as a CFO will provide stability to the Company as we see our operations meet demand for the rapidly expanding cannabis market.
Moreover his experience at public companies will prove invaluable to us as we work to establish stocks compliance and his cross sector experience which encompasses both consumer product businesses and the energy sector means he is uniquely positioned to drive our business, which touches several different industry verticals. While we are completing this transition, Jim will run through the financials on the call today and Chris will assume the responsibility next quarter.
Earlier this month as part of our long-term growth initiatives, we also formed a new Advisory Board to provide strategic advice and expertise to help accelerate growth to manage risk and enhance operational performance. The Board is comprised of three members Matthew Morgan, an entrepreneur and business consultant with leadership experience in the cannabis and other CPG industry. Eric Schmidt, an industry veteran in the liquefied petroleum gas industry and Ali Jahangiri, a digital publishing pioneer who is established and grown several businesses. The members of the Advisory Board will provide insightful recommendations in order to further advance our goals of becoming a leading provider of a diverse range of products and services across the number of industry and verticals both in the cannabis industry and beyond.
As you can, see we are laying the framework for major growth this is because we are seeing the market develop at very rapid pace and we want to be poise to take advantage of this opportunity that continues to evolve. I’m now going to talk a little bit about the market trends that we are experiencing and how we have position ourselves to take advantage of them.
In California, we are still seeing the licensing program continue to unfold and we believe the state remains in the early stages of the regulatory framework. Regulators continue to issue additional licenses and a change of practice have begun for the first time issuing one year licenses, but state is expected to finalize these regulations for the cannabis industry by January 1, 2019, at which time we expect more of our customers to regain compliance and once again have the opportunity to be able to purchase from us. Over the next three to four years, we expect California to continue to have tremendous growth opportunities for our business and we expect the market as a whole to continue to become more professional and more robust.
In Massachusetts, we have invested heavily in the development of our new warehouse facility in Worcester, which is set to serve as our East Coast hubs supporting business entering the industry or expanding operations within the East Coast market. Adult-use cannabis sales have now commenced in Massachusetts, which we believe will be a catalyst for the emerging East Coast market. While California has attracted in abundance of attention, we believe the East Coast market could grow to be larger than that of the California at that maturity and our new facility positioned us to be a first mover in this emerging market.
As we mentioned previously, we now have the team on the ground in Canada, taking advantage of the rapidly evolving market that has significant growth upside. With the opening of our Canadian subsidiary, we now have an operating entity, established relationships with top LPs and meaningful sales within that group. We expect the market to open up and demand declines steadily for infused products extraction, vape and edibles which is not even in the market today will represents another major growth catalyst. On a federal level, we’re seeing the states act as potential paving a way for a legal cannabis economy with the government recognizing CBD as well under some of the bills that are going through the Senate.
The recent midterm election earlier this month also proved to be a win for the cannabis industry with Michigan voting to approve adult-use cannabis and Utah and Missouri voting to approve medical cannabis. Also Jeff Sessions who has been followed the cannabis industry resigned from his position as U.S. Attorney General following the election. Internationally, the market continues to open up as well with the Supreme Court of Mexico overturning the country’s ban on adult-use cannabis among other developments.
As you can see we’re tremendous excited by our position in this explosive market, our goal is to be generating over $1 billion in annual sales sometime in the coming years. The market opportunity and our position across multiple verticals in the industry, combined with the initiatives that we’re implementing to ensure that we exponentially grow our sales, puts us in a great position to be able to achieve these goals.
On that note, I’ll now turn the call over to Mr. Jim McCormick to talk through the financial results from the year.
Jim McCormick
Thanks Nick. I will now provide detail about this year’s management results. This can also be found on the Company’s Form 10-K which we filed with the Securities and Exchange Commission later this week.
Total revenue increased to 177% to 52.1 million in fiscal 2018 from $18.8 million in fiscal 2017. The increase in revenue was primarily due to overall growth in sales as a result of an increase customer number, average orders size and expanded product offerings as well as opening of new market. Both profit increased to 12.6 million in fiscal year 2018 up from 6.6 million in fiscal year 2017 as a result of the overall growth in sales.
Gross margins were 24% in fiscal year 2018 compared to 35% in fiscal year 2017, reflecting higher cost in sales resulting from the rapid growth as Nick outlined. It should be noted that if the year-end inventory adjustment of 2.8 million has excluded the Company’s gross margin would have been 30% for the full year.
Operating expenses in fiscal 2018 were 25 million compared with 6.2 million in fiscal 2017, primarily due to an increase in SG&A costs which were 24 million in fiscal 2018 as compared to 5.9 million in fiscal 2017. The cost reflected at the extended operational footprint as well as increased headcount at levels of the Company. The net loss for fiscal 2018 was 10.2 million or $0.16 per share as compared to net income of approximately 69,000 or $0.00 per share in fiscal 2017.
At August 31, 2018, we had cash of 13.5 million and working capital surplus of 40.2 million compared with cash of approximately 917,000 and working capital of 3.4 million as of August 31, 2017.
With that, I’ll now turn the call back to the operator for the Q&A session. Yes, go ahead.
Question-and-Answer Session
Operator
[Operator Instructions] We’ll take our first question from Vivien Azer with Cowen. Please go ahead.
Vivien Azer
So, Nick, thank you so much for all of really the transparent candid commentary around some of the spend items in the fourth quarter. It does make sense to me that those are prudent and hopefully transitories as you articulated. So I just wanted to dig into a couple of those components, if you will. First is on all on the air shipping. When do you think you’ll be able to transition more completely to go across the waters?
Nick Kovacevich
Well, good question and the problem is that the air shipping may come up again but in different SKUs. So the specific problem that we had with the 3 ounce chart, that’s in the process of being solved and actually we’re currently both shipping most of our jars, supplementing with a few airshipment and we’re on-boarding a brand new factory that can produce at a significantly bigger scale, and I believe that factory goes into production right now this week or next week and then we will be able to get ahead of it, and so that one SKU will be solved. So, hopefully right, we can continue to stay on top of this and anything that we see as a fast growing SKU, we can make this transition quicker, but there could be a scenario where another SKU picks up significant demand and we’ve to go back to this same issue.
But this one example was sort of a learning lesson for us in terms of what we could do better upfront, and how we’ve to be evaluating our factories along the way. So, we don’t get caught in a situation where we’ve this big gap, but we’re in the factory that simply could not produce enough, so no matter what we had to airship until this new factory got up. So, we’re building some redundancy in our factories. Our teams over in China right now addressing some of these issues, and so we think with a better approach upfront, better planning along the way and quicker reaction time on the backend, we should be able to mitigate any of these effects happening on additional SKUs, but for this specific SKU the problem should be solved.
Vivien Azer
And then on the inventory write-down in California, will there be a continued residual impact into the first quarter of ’19?
Nick Kovacevich
We did our best to sort of clean everything up in this quarter because the California transition happened, as of January 1st and there was another rule change midyear, we cut some of these product that we were thinking would potentially be viable until we found out that the new proposed draft ranks were going to render these obsolete and so we just felt that it was time to write them off. Jim can opine on a little bit more, go ahead Jim.
Jim McCormick
Hi, it’s Jim. So, I’ll just add to that the big two take care of this with WM System and the Manhattan platform, it’s not that just flip the switch, it’s going to take months to get that up and operational. So in the mean time, we put in place some very aggressive kind of stopgap methods and procedures until we have that system live. So I would love to say it’s all behind us, but we saw in the midst of all these growth and new facility coming online. So it’s work in progress but we have a clear plan to address those.
Vivien Azer
And then Nick, in your commentary on kind of ultimately kind of targeting a normalized margin of 30%. The questions that I’m asking are trying to kind of get us to that point. I mean, is that something that you think is obtainable at some point in calendar 2019 or is it a longer term target?
Nick Kovacevich
We’re reluctant to commit anything at this point although obviously it’s a goal to get up to that 30% mark as quick as possible, pushing to get it by Q4 this year, if not it’s going to be at some point in next fiscal year. But the reality of the situation is, we have our fixed cost on what we buy product score and what we sell them for. And the numbers if you look at those, it’s just the raw numbers. The margins are great, right, even vape our lowest margin category is over 30%. Some of the higher margin categories are in the 50%. And that’s just gross products cost versus what we sell for on average.
What’s bringing those margins down? Well, it’s all this other stuff that goes into COGS are obviously inventory adjustment and we got to get that fixed which we have the plan to do, but also the air shipping fees that come in. The operational and efficiencies, we are looking at data, we had our warehouse in Massachusetts up and running a couple of months ago, and we’re looking at how many shipments were still sending across the country direct to a customer. And the reason is because we are behind on some of those products, so as soon as we get in on the West Coast, we airship it to our customer on the East Coast. What we should be doing is maintaining a decent stockpile of backup inventory in our Massachusetts facility, reducing the operational cost and moving that inventory around.
So a lot of these cost are coming up and they are ultimately impacting our gross margins and another one for example in our credit card fees, we pay in the 5% to process credit cards which is extremely out of the norm for traditional businesses. So some of this banking stuff gets fixed, those fees go down. So there’s a lot of stuff that can happen and that can actually reduce the amount of stuff that’s going up and driving these margins down, and we just don’t know exactly when that’s all going to happen but we have plans in place to help execute on that.
But one wild card is if there’s another spike in demand on certain product again that may leads to more shipping cost or more of these operational cost that could ultimately lead to us not achieving that goal within the timeframe that we want to, but we believe the pieces are in play and we believe that with the plan that we’re executing against, we can get to that goal either by the end of 2019 or certainly in fiscal year 2020 to answer your question.
Jim McCormick
Yes, and I would just add to that, last year was an exciting year for a lot of reasons but one in particular was we really — you’ve heard the word many times scale, so our volume now is to a point where we can go to vendors and actually get better pricing across the board because of our scale. So, it’s really exciting on all fronts, but it’s one of these beautiful snowballs that as we get bigger, we demand more pricing, we become more attractive to customers and on and on you go. And really last year is when we saw that tipping point of getting the scale necessary to leverage our size with our vendors.
Nick Kovacevich
Yes, that’s a great point Jim and just to expand on that for one second. To give you guys an idea on this product like this 3 ounce charge. What was happening was we’re with the vendor that when you’re doing a couple 100,000 units a month that’s a type of vendor that you go to. When you’re doing 3, 4, 8 million units a month, there is a different quality of factory that you partner with. And what that partnership allows that the change in factory to upgrade is it allows us to reduce the air shipping cost. These charges specifically we’re actually dishwashing them at our facility to make sure that they are clean and sterile for our clients. That’s incurring labor cost right now of almost $18,000 a week that’s going directly in the COGS because our manufacturing partner is introducing in a clean room environment.
Again, our new manufacturing partner, that’s going to be able to produce millions and millions of unit per month, will be producing in a clean room environment. It will be doing quality control check at factory and they will be shrink-wrapping that product before sending it to us. So this is one example, it’s a microcosm, but ultimately this is happening across the board whereas we’re able to upgrade our vendors, we’re able to eliminate on necessary cost like air shipping and washing the jars and we’re also able to get lower cost as we’re now buying a bigger scale. So exactly to Jim’s point, it’s all starting to come together and we’re going to see throughput of that in the coming quarter but it’s going to be an ongoing battle because we have so many different SKU, some of them we’re getting scale, some of them we don’t yet have scale on, so remains sort of a challenge, but it’s something that definitely moving in the right direction.
Vivien Azer
Well, that’s certainly encouraging to hear. Last one from me. Just thinking about the top line, so fourth consecutive year of triple digit growth, very impressive, so kind of thinking about on balance new market opportunities like Massachusetts and Canada coming online versus meet perhaps normalization of in-growth rate in markets like Colorado, which seemed to decelerate over the course of the year. So how should we think about the balance of that?
Nick Kovacevich
Yes, we wanted to show the data on our growth in these states even the states that aren’t growing as much like Colorado and Washington, we’re still growing and what that means really the reason why is obviously we’re offering more products based on products we weren’t offering in those we now are. For example, our energy footprint was not even established in the pacific North West until a couple of months ago. So we’re continuing to expand our offerings into these markets and we’re able to capture more revenue in those markets but we’re also seeing is that our business is becoming more effective. So the clients in these markets as they grow, they look to us as more of a robust supply chain partner that can support them and what we’re seeing is the larger operators are outgrowing a lot of our smaller competition.
So if you go to a cannabis trade show, you’re going to see a lot of different packaging companies, you’re going to see other base company. You are even seen other hydro carbon gas company, but the reality is anybody that exclusively operating in Cannabis today has very little scale and they don’t have a lot of balance sheet support. And so these larger operators that are now emerging these multi state operators that have significant growth plans that are making acquisitions. They are getting to the size and scale where they are simply outgrowing those other product offerings ancillary companies that we’re competing against and as a result a lot of that business is now coming our way. So we’re actually getting more market share in some of these smaller markets or some of these older markets, which has led to our impressive growth numbers versus the overall growth of those markets.
And then what can we say about future potential on upside, well, we obviously just came out with guidance here that we expected to do 110 million to 120 million in fiscal year 2019 coming off of a $20 million fourth quarter there’s still some significant growth in those numbers. But those numbers are also being very conservative around the markets that are opening up. We really think we can hit those numbers just with the continued momentum in California, obviously continued momentum that we’re seeing in markets like Nevada and Oregon, and Colorado, and Washington. Some of the smaller markets with some new emergence of the Massachusetts legal market and of course with the emergence of the Canadian market, but we’re not baking in any emergence in states like New Jersey or even Michigan that voted in. None of that’s baked into our guidance and our projections, so we believe we can continue this type of growth. And if these markets open up quicker than expected, that’s when we’re going to add to the growth that we’re going to be getting. We’re not relying on that happening to hit our growth numbers.
Operator
Thank you. We’ll now take our next question from Paul Penney with Northland Capital.
Paul Penney
Not to kick a dead horse, but going back to the margin issue and questions. Can you remind us of the margin profile range of the energy and natural products in the paper segments?
Nick Kovacevich
Yes, so the range that we just look at, what we buy the product for and what we sell it for. In the Energy and Natural products, we’re in the low 50% somewhere between 48% and 53%, just in terms of that gross margin from our product costs to our average selling price. On the paper and cones, we’re in the mid to low 40s, and even on the packaging, we’re in the mid to low 40s as well. So, the only product where our actual costs versus our average selling price is in the 30% range is the paid, category obviously represents a such a big portion of our 2018 sales, it was something that did not help our overall margin. But as we diversify out of that category into the other categories and as we get our operational efficiencies out and we continue to bring less additional costs up into the COGS, we believe that obviously our overall margins will improve significantly.
Jim McCormick
And as well as like any sale and distribution companies more throughput, we get through our systems, obviously the more efficient we are, and the better our profile; so all that’s coming to fruition as we speak.
Paul Penney
And going back to the packaging side, can you talk more about your Koleto and Creative Design group separates? And how you see the breakdown between your stock and traditional and your brand in custom business evolving overtime?
Nick Kovacevich
So Koleto is something that we really wanted to invest in which is why we made a separate operating company. We’re extremely excited to have Steve Wang running the division. He’s the President, based in San Francisco, but travels to our HQ in Garden Grove, at least once or twice a month. And he has a team underneath and these are going to be mechanical engineers, designers, people that know how to make products, and they’re going to work in two ways, they’re going to work with myself and senior management and our sales staff to determine market gaps.
So we know the market really well, we know the regulation in each market and so we can determine where there is an underserved category, and we can work to create a product that we know is going to be a mass market hit and there is certain criteria that we evaluate before bringing a product to market. Obviously, There has to be market potential on upside but we also have to have a certain price point on that item so we know to it can move in volume and in scale because the market can only bear certain cost for each item. We want to make sure it’s customizable and brand-able so our client can differentiate. And we got to make sure that its complaint that it meets and exceeds the regulations in the market we plan to offer.
So if we can check all those boxes and we can work just as a company to create our own products, there are unique proprietary hopefully they have defensible IP built into them and we can produce them for mass-market distribution. So that’s one way that Koleto will work. The other way the Koleto will work which is actually even better is they’ll work directly with our clients. So client comes in and says, hey, I want something different. I need to stand out on the shelf. I’m trying to build my brand. My investors want me to get more market share and more engagement with my end consumer.
Can you build me a product that’s unique proprietary to me? And our Koleto team can do that as well. We will fly them out to meet a customer. We’ll fly a customer in to meet our team. We will do a workshop session we will figure out inspiration thesis that they are looking at and then we will design around that, we will design in CAD we will give prototype and then our customer will ultimately decide and commit to that product. And a lot of times we can build our own IP into those products or build unique IP for these specific projects but once we have blocked it in it comes along with the long-term supply agreement because that’s going to be the package of choice for that customer.
So we like when its customer led because it’s a guarantee locked in business but sometimes the customers will negotiate exclusively or semi-exclusive or certain geographic exclusivity on those products. So the product may not be as big of a mass-market fit as working from the other direction but we know there is a guaranteed buyer for that product if we work directly to our customers. So that’s the two ways in which Koleto will work and over the course of this year and certainly next year the hope is that we are going to get more clients into custom proprietary products there is specific for them. We see this being the trend amongst the larger operators overseeing this in Canada today that the LPs that have a lot of money at their disposal they want to differentiate, they want something unique. So we don’t have the exact numbers but we know that this is going to be where the market is moving which is why we invested in this division.
And we believe we are the only company that has this position to be able to service the segment because we are the only company that actually knows this cannabis market really well. We know the regulations and rules in which these clients are operating. We know the different products form factors they need to packaged and how they need to be packaged. And we have a team ready to deploy at a moment’s notice to be able to service these clients. So we are in a great position. We see the market moving in this direction. We don’t have exact numbers but we expect out of our packaging business that over time more than 50% of the products that we are producing and selling are going to the custom proprietary build products for either mass-market that we have designed or client specific has been introduced by acquired relationship.
Paul Penney
Great, that’s a lot of great color Nick, thanks. And last question for me. Is the painting and upgrade off of the OTC onto to a major exchange still a top priority? And if so, can you give us some color on some of your near-term efforts and timing expectations?
Nick Kovacevich
Yes, great question and it’s certainly one of the top priorities of the Company, which is why you have been seeing a push for us to expand our internal controls to become stocks compliant. We have the independent board, so we’ve sort of done a lot that we can do on our end and ultimately we’ve also retained council to be able to put ourselves in a compliance position to be able to be accepted by one of the major exchanges. We’re feeling very optimistic of course with the change in sentiment with the recent election, that we can be one of the first cannabis companies in the U.S. to be able to be listed on one of the major exchanges. But at this point, we can’t give any specifics to where we’re at with that process or any specific to the exact date in which we expect it to occur. But just know that it is underway, it is the top priority as the Company and we’re very optimistic about our chances of making that happen in the coming months.
Operator
Thank you. We now take our next question from Mitch Baruchowitz with Merida. Please go ahead.
Mitch Baruchowitz
Jim, Nick, thank you so much for all the information. So just a quick question on, where you guys see the impact of your new proprietary products versus the other SKUs that sort of the other me too products that we made? So you guys obviously have done a good job of building a bunch of complimentary companies and divisions inside. How much do you plan to spend on R&D? And as Nick said before I think it was Nick that, typically, packaging cannabis people want individual, they want tools and stuff that that definitely make them stand out on the shelf. So how much are you planning us on R&D? And what is the impact? Obviously, it’s a large organization you have a huge advantage over smaller organization. But how much do you plan on driving home that advantage?
Nick Kovacevich
Yes, so our operating budget for fiscal 2019 includes $2 million to be invested in this R&D that you speak of and we believe it’s obviously going to be very well served because these products are first of all more in demand. We’re building products to what the market needs. Secondly, they are defensible, people can’t knock them off. And thirdly, they typically come with higher margins. So we believe it’s a very wise investment they we’re making, but ultimately to your other point it’s something that’s going to gave us the huge competitive advantage because none of our competition can make that size of investment in their R&D division, and we’re doing it from the position of great insight.
We were interacting with the clients in the market on a daily basis. We have the largest outside sales force. They’re relationship builders. So they are in the field, they are talking to our customers and they are aggregating all of the feedback from the markets and all of the different states and internationally and bringing that into our R&D teams so that we can make well guided decision in terms of which products we want to invest into. And so, we’re making some investments and some bets in certain products today.
We were relying on customers that want us to build certain products for them as well and we’re doing some of that. But we believe that it’s an ongoing process, but we’re going to refine and get better at. And ultimately, when you look at trying to build out this portfolio, the best way to have a competitive advantage is that mostly your portfolio is defensible with IP and that’s ultimately our goal, but it’s going to take us a few years to get there. We’re very excited about the progress we’ve made so far and Steve has done a great job in building out the right team to be able to execute on this strategy.
Jim McCormick
It’s Jim. Yes, I’ll just add to that that our emphasis is trying to rollout obviously have a product pipeline, so we can bring new products to market on a consistent basis. But also when we bring new products to market, we are looking to have the ability to actually run it across different platform so we would have poly jar, poly box whatever which would have mass customers appeal. So, we’re trying to stay away from one-offs unless it’s really high volume.
So that’s the whole approach and we got number of things in development with high marketability based on them they have branding, branding is everything right now and of course it’s a dark market environment. The appeal has to be at the point of sales is probably the best brand weapon you got right now. So all of our emphasis is now supporting that and packaging is a key part of making that happen as well as our in house labeling and printing division which also support our marketing, and gets these brands to market.
Mitch Baruchowitz
And one just follows up question. As you guys know we’re data fanatics at note. So what are you guys seeing in terms of as Nick said, you getting a ton of customers feedback, on product, on individuality on packaging size, on all kinds of assets that you can collect. Now that you’re in Massachusetts and some of the East Coast market that didn’t exist two years ago, when you guys were really starting to beginning of your ramp. What are you noticing so, it’s a two part question, what are you noticing in restricted medical markets as they start to unlock new source? And second, how are you guys preparing for some of the states as they go like a Michigan that goes from to medical to rec very quickly or from Massachusetts which is only really two or three years from full medical implementation. How can you prepare to be ahead of the curve because obviously demand for packaging is going to explode if a state like Pennsylvania or Maryland goes rec?
Nick Kovacevich
To your later part, I mean really we have to make some bets and if you look at our Windsor facility, it’s probably a bigger facility than we need today, absolutely. We got in there several months before legalization. Obviously that was a moving target, originally they wanted to roll it out in 2017 and it got moved to summer of ’18, and they didn’t actually commence any ability to use sales until couple of weeks ago. So, that’s something where we have to make that investment. So, we spent the money, we put the facility, we built the team, we start developing relationship. And our overall revenue generated out of that facility and out of that team is not necessary justifying the cost today, but we’re going to see this market open very quickly in Massachusetts is my guess, we’re going to see singing a different tune either in our next call or certainly the one after that those investments have paid off for us and continue to pay off.
So again it’s about making these investments and these bets and Michigan is another great example. Who knows when they are get it legal they are have an aggressive timeline to roll out the program, we know there is an existing medical market today which consists of a lot of grey operators and that’s tough for us. We’re more focused on been able to deal directly with legal compliant operator but there is some navigating in the current medical market that we can do today, but we have to make an investment, to get ahead of that for adult-use. Those relationships are key and what we’re seeing though which works to our benefit is these larger multi state operators that we’re really strong with, they are moving into these new markets.
So we get to take advantage of it by being attached to them. Great example GTI is a customer of ours and they recently acquired, announced they are going to acquire Essence in Nevada. We don’t work with Essence today. But hopefully post-acquisition they will be customers of ours through GTI. So, we have an advantage if we align with the folks that are out, they are being the acquired and expanding into the new markets. We’re going to be able to benefit from that because we already had that relationship. So the first part of your question about what we’re seeing in the limited license markets versus some of the open markets more of the markets like Oregon, Washington, and California and Colorado. We’re seeing that obviously with limited competition it means that the need for differentiation is not as apparent.
So I think the smart operators are the ones that get ahead and really build consumer royalty are going to make those investments because ultimately it’s about investment in their consumer, their customer. But it’s not necessity because again when you’re in a limited license market, you’re not competing against a ton of folks. So you’re going to get your product to the shelf, your product are going to sell, regardless of how they’re packaged or how they’re represented; now move to a market like California where it’s highly competitive it’s a brand war, shelf space is at a premium, but It’s a necessity to make these investments in differentiation. Markets like Massachusetts and Maryland it’s not a necessity today, we see the smart operators doing it, but we believe the markets are going to continue to open up and evolve over time and ultimately if you want to be the next Budweiser, the next Corus of cannabis you need to make those investments and that’s the message that we’re pushing to our customers.
Jim McCormick
Yes, I’d just add, Mitch when you see a market like Michigan open, it’s our operations team, becomes more developed and we get more horsepower on that team, the model could be to get into the market very quickly, it’s just a 3PL distribution centers. You can bring that online very fast, I don’t think we want to open up big distribution centers on a whim, abusing it badly, it takes a long time. So there’s different ways that we can go after these market in a cost effective and timely manner.
Operator
Thank you. We’ll take our final question from Alan Brochstein with 420 Investor.
Alan Brochstein
I had just a couple of questions on your outlook for next year and you’re dealing first. This is really the first time that Canada has had any sort of contribution and it’s hard to tell because Canadian [indiscernible] after your quarter. So as you looked out next year, you kind of touched on this, but how much of the growth that you see next year is coming from Canada? How do you envision that playing out? Is this a sustainable type of number this quarter? Or — and then also as the rules evolved there with branded product is that an opportunity?
Nick Kovacevich
We’ve seen in towards the end of our fiscal year a boost from Canada obviously continuing into our Q1 which has not been released, but we expect that to be a continued trend as obviously they’re selling out of the product that they have up there. Where we’ve seen the most benefit is around the pre roll category, this is a new category to the market up there, and we see an adult-use market gravitation of customers towards readymade products. While in Canada what you don’t have is you don’t have popular product like vape which represents over a third of the sales in California today, we also don’t have edibles.
You don’t have a lot of these readymade products so one of the readymade products that they do allow is pre rolled joints. You can smoke right out of the gate, and so we’ve seen an uptick in products that align with that sector for the Canadian market. So, it’s a lot of good things, we like about Canada. Number one, it’s a limited group of LPs that we target. They’re typically bigger in size, so they need a more robust supply chain partner like us. They just can’t work with a lot of these smaller guys that we compete against which is a good thing.
The momentum in the market is a good thing. But the downside of the market is again, it’s only flower and cones pre-rolled cones and pre rolled joints and tincture oil and capsules and things like that. We are missing a lot of the market with vape for example because we can sell hydrocarbons upfront we can sell terpenes we can also sell sale the vape cartridge itself. We don’t get any of those sales in the Canadian market so for our product category breakout packaging itself was less than 30% of our sales and then the papers and supplies around 10% of our sales.
Those are really the two main buckets that we have available through the Canadian market today and the vape bucket which represents over 50% of our sales is not really available only for CBD, right now in Canada. So that’s the one thing that’s hurting us in Canada but we are excited about the upside and if they can get vape and get edibles in place over the next year then it’s going to be a very robust and healthy market for us.
Jim McCormick
This is Jim, I would just add to that. Canada is going to be a marathon not a sprint. Obviously, the other products coming online next year dealing with that tobacco like marketing restrictions in Canada the full potential that market down the road for us. We see it as a long run going to be very good for us but there is going to be some turbulence as that market evolves and matures.
Alan Brochstein
And then the next question you gave some guidance for next year, sounds like a lot of growth. I want to double check and see how much acquisition you might be building into that if any at all?
Nick Kovacevich
Yes, so we are really excited about as I said on the script that out of the $52 million we did in sales in fiscal 2018, 55 million was attributed to organic growth or categories that we already had in place. So, the 2 million additional revenue was driven by the energy products that we acquired on May 1st, so we only have four months of those revenues in our fiscal year numbers and then also the creative agency that we acquired in June, which is our first business unit produce service revenue.
So neither of those made a huge impact in our 2018 numbers but certainly it should be showing up bigger in our 2019 numbers. So we think that we can achieve significant organic growth in the guidance that we put out is really built around the organic growth that doesn’t include additional growth that we could receive from acquisitions. And so what we have been strategic about today is making acquisitions that help diversify the business and that only makes sense if you can effectively cross sell and integrate these products but we have demonstrated that we can do that.
We purchased CMP Wellness as a vape distributor in May 1 of 2017 and they were doing approximately 8 million in sales and we were able to generate over $20 million in sales in one year period post-transaction. So that’s an exciting organic growth story around the acquisition story. So we make an acquisition, we integrate it, we cross sell it and we grow it organically. So I think there is potential to continue to do that in 2019.
And the one thing that is the challenge for us today is we have diversified the business really well. We have grown the revenues significantly. We have done more entrenched more sticky with our existing customer base. We feel what we have significantly increased the value of our business, yet our stock is still trading near when we did our last deal back in June, when we did our last acquisition of Hybrid Creative price to $5 a share, when we did our acquisition of Summit Innovation price at $5 a share, we’ve created all this in our opinion exponential significant value yet the market has not been able to reflect it.
So I think at this point with our stock trading where it is, we’re going to be much more focused on just executing on our business model. It’s working, we’re getting more and more organic growth, we’re going to put our head down, we’re going to focus and we’re not going to be as concerned about acquisition. Obviously, as that growth drives more value in the market place and if our stock goes up, that will put us in a position to then go back and revisit additional growth by acquisition which we intend to do.
But it’s not necessarily a bad place, it’s a place we are sort of forced into, but the good news is we have enough opportunity in our current domain that we can just put our head down, focus on executing and getting that organic growth. And hopefully the market takes care of itself and then opens as up to go back to an acquisition growth to expansion model as well.
Alan Brochstein
And that leads to my final question in terms of once your stock is back on track in your view. What would be some of the areas that you would be looking to make further acquisitions? Would it be additional beyond the five areas you have now or tuck-ins within your current footprint versus geographical what are similar things you might be thinking about in the future?
Nick Kovacevich
I think traditionally we’ve been interested in getting into the other high growth segments. So if you look at what we’ve done and where we’ve invested our dollars, we’ve invested and significantly into the pre-rolled category we did that in producing our own molds for our pre-rolled packaging as early as three years ago. We’ve done that in garnering exclusive distribution agreements for some of the paper products that are driving this category, that’s proven to be a great move because we see the data showing pre-rolled are one of the fastest growing categories in the industry especially in states and markets like Canada.
Again, it’s a readymade ready-to-go product and in adult-use markets those that’s where the trends are moving. We’ve also made significant investments into the extraction of our oil category. We did that with the acquisition of CMP Wellness, to get us into distribution of vape hardware cartridges and batteries and we did that with the acquisition of Summit Innovations to get us into selling hydrocarbon gases as insolvents, butane, hydrogen and ethanol which is a material the raw material required upfront to be able to begin the extraction process, and we’ve also diversified into offering terpenes which grows along with this same oil extraction category, where we stayed away from categories like growth supply, which we believe is the category that’s going to be declining in terms of its growth numbers and it’s also going to be declining in term of its profitability.
So we stayed away from those categories so we continue to have a pulse on the market. We continue to look at where are the high growth categories and what are some additional products offerings, that we can position ourselves to be effective in. We’re going to continue to evolve on that strategy we don’t have any specific categories in mind, even if we did we probably wouldn’t disclose it on this call, but I think we can look at making acquisitions that can help us diversify if those come about. But to your other point I think this could be a time if we’re in a strong market position where we can actually buy some competitors as well. And the reason is because I think there’s some desperation in the market, lot of the competitors that we compete against are small, if they are getting to the point where they are generating 8 to 10 to 12 million in annual revenues that’s typically a point where a start-up business needs to now bring on outside capital.
These companies aren’t in a position to raise outside capital, so that’s not going to be a fun process for them. So, they are turning toward acquisition as a potential exit strategy. Now if we’re in a position where we can negotiate really good deal terms that could be an effective strategy going forward as well. So because of some of the market conditions, we could turn toward a strategy of rolling out some of the smaller competitors but really where we see more value is in buying businesses that diversify it, should does come about. We’re going to look at both but again here in the short-term we’re going to be more heads down focused on organic growth because we have a lot in front of us that we can do just with the team that we had and with the product offering that we have today.
Jim McCormick
Yes, Alan, ultimately actually the answer to your question is pretty simple. Our customers will lead us to any potential new vertical, but we are closer to the U.S cannabis market, I would argue than any other company given our breadth of customer base. So, we have our finger on the pulse of this industry and when we see something moving and if it fits into our ecosystem, we will be interested in it.
Operator
Thank you. And it does conclude today’s question-and-answer session. I would like to turn the conference back over to management for any additional or closing remarks.
Nick Kovacevich
All right. Well, first, I would like to say thank you for everybody who participated on the call and asked questions. It was a very helpful and we’re glad that we can expand upon our story and give the message out there to the market and thank you guys for the help that each of you do in assisting in that.
I would like to close. But before we close the call, I would like to emphasize that we’re extremely pleased with the growth we have experienced over the last year and we’re even more excited of the growth to come. Our business model continues to function exceptionally well and our products are seeing record breaking demand.
We continue to diversify our revenue sources to provide long-term defensible mechanisms including the development of highly valuable intellectual property like Koleto packaging solutions, our wholly-owned operated R&D division this will protect and reinforce the staying power of our business for years to come.
With this tremendous growth has also comes some growing pains and we’re pleased that we have been able to identify and address these issues and produce initiatives that we previously discussed that we believe will help fix these over the course of the long run. These initiatives include the retention of the consulting firm to help with our process. It includes the hiring of a financial veteran, Mr. Chris Tedford as our new CFO. It also involves the formation of our Advisory Board to provide expert insight on our growth trajectory.
And preparing for dramatic growth, we’re instituting scalable solutions that will enable us to more effectively capitalize on the dynamic market opportunities in states like Massachusetts and California and countries like Canada and as well as emerging markets, and we are confident that were positioned to take advantage of the dramatic growth in this industry, scaling the business to hopefully over billion dollars in sales in the coming years. And for fiscal 2019, we believe that we can achieve a range of 110 million to 120 million in top line revenue as we continue to gain market share and continue to have a better product offering than our competition.
Furthermore, we’ve also engaged BDO’s Risk Advisory Department to assist in achieving Sarbanes-Oxley Section 404, SOX 404 Compliance. Achieving SOX compliance can improve processes and maximize business resources. The new SOX compliance is something we know will speak volumes to the investment world on how serious we’re in our future as a publicly traded company.
And once again, I’d like to thank everyone who has joined our call and we look forward to updating you all again in 2019. Thank you.
Operator
Thank you. That does conclude today’s conference. Thank you all for your participation. You may now disconnect.
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