The Valens Company Issues Letter to Shareholders & Announces Initiation of Second Wave of Integration Initiatives to Increase Efficiencies and Drive Additional Cost Savings

– The Valens Company Inc. (TSX: VLNS) (Nasdaq: VLNS) (the “Company” “The Valens Company” or “Valens”), a leading manufacturer of cannabis products, today released the following letter to shareholders from the Company’s Chief Executive Officer, Tyler Robson, and President, Jeff Fallows outlining the rationale for the recent financing. The letter also provides an update on the first wave of integration initiatives announced in early February and introduces a second wave of initiatives which are aimed at delivering additional operational and organizational efficiencies in the coming quarters as the Company continues on its path to profitability.

Dear Shareholders:

As you have seen, we launched and closed a bought deal financing for gross proceeds of US$28.75 million (the “Financing”), which included the exercise in full of the underwriters’ overallotment option, through a syndicate of underwriters led by Stifel GMP and AGP. The decision to pursue this Financing was not taken lightly. As shareholders ourselves, and stewards for capital invested by other shareholders, any issuance of equity capital is approached with caution and must only occur based on a compelling rationale and a belief that the issuance will improve the potential for us to increase shareholder value in the future. We wanted to take this opportunity to provide this rationale and clearly articulate why we believe this action was in the best interest of our shareholders. The Canadian cannabis legal reforms have provided a once-in-a-lifetime social and financial opportunity to build a new consumer products industry but the challenges currently facing the sector are real.  Companies with innovative products and the financial flexibility to execute against their strategic focus are best positioned to survive these challenges and be the leaders of the industry who will benefit in future years to come. The rationale for the Financing includes the following:

1. Managing Working Capital and Cash Cycles: As demonstrated by our Q4 2021 performance, we have successfully transitioned into a branded B2C company, with almost 75% of our revenue coming from this category. We have seen very strong success in growing market share in Canadian provincial sales as demonstrated by the growth of our flower brands including Versus, Contraband, and Citizen Stash. As of March 2022, we have the #1 best-selling flower SKU, in BC God Bud, across all product categories in the first three months of 2022, despite not cultivating cannabis flower ourselves. As discussed on numerous occasions, we do not believe that owning cultivation assets in an oversupplied environment is an effective strategy. However, our asset light strategy has required a higher working capital investment over the last few quarters to cover the cash cycles needed to purchase targeted strains on the spot market. More specifically, we have had to purchase biomass for cash up front and have typically experienced a minimum 90-day cash conversion cycle to provincial revenue. In addition, we have also increased our investment into inventory to reduce stockouts for our core brands which continue to experience rapid growth. As we have launched new brands and new products it has caused, and is expected to continue to cause, some near-term volatility in inventory balances. However, we expect investment in inventory to stabilize by Q4 2022, as consumer demand and purchase orders of our products achieve a more normalized level of sell-through and lead to tighter inventory management. In addition, we are in the process of executing new contract grow arrangements and tightening our accounts payable and accounts receivable cycles to optimize cash management for the business. However, at this time further capital was required to ensure we meet growing demand.
   
2. Financial Flexibility: The ‘Integration Initiatives’ and decisions we have made over the last 90-days are expected to positively impact our cost structure in the second half of the year. At the same time, ongoing inflationary cost pressures, a volatile supply chain, and heightened geopolitical risk are not expected to ease in the near term. Faced with this reality, we took steps necessary to strengthen our balance sheet and provide additional financial support to our business until the benefits of our ‘Integration Initiatives’ are realized, and our operating environment normalizes. As we continue to broaden institutional and public reach initiatives, we are pleased to inform our shareholders that the Financing was led by a CPG-focused US institutional investor and included both Canadian and US institutions.
   
3. Growth Initiatives: We are evaluating two strategic areas for potential investment in 2022:

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  • Internalizing Manufacturing at Green Roads: While Green Roads maintains a strong portfolio of cGMP manufacturing capabilities, there are nevertheless opportunities to bring additional expertise in-house. This remains in-line with the opportunities for synergies we saw when analyzing the acquisition and provides an additional opportunity for Valens to leverage its Canadian-based innovation expertise south of the border. Several of our outsourced products have been subject to manufacturing variability and stockouts which can be addressed in the near and medium term through both partner optimization and investment in our internal capabilities.
    
  • Discounted Assets: We have committed to our shareholders that our first priority in 2022 is to integrate previous acquisitions and to right size our cost structure before pursuing any additional acquisitions. As we continue to make progress on this objective, we will become increasingly opportunistic to take advantage of the growing number of attractive assets in both the US and Canada which are hitting the market at significantly discounted prices.

Reaffirmation of Key Performance Metrics

The Financing provides greater certainty in our ability to execute on the key performance metrics that we have identified for our business in 2022. We expect revenue growth and profitability improvement to be key themes in 2022 and we reiterate Valens KPIs as follows:

Key Performance Indicators for 2022:

1. Grow adult recreational market share in Canada by becoming a top 5 Player in vapes, edibles and beverages and a top 10 player in flower products.
2. Unleash our potential in the U.S. and international markets through the Green Roads platform which was acquired in April 2021.
3. Achieve positive adjusted EBITDA by Q4 by improving the gross margin and SG&A profile of the business through our ‘Integration Initiatives’ which are based on a combination of cost efficiencies, realization of M&A synergies and greater levels of automation and process standardization.
4. Reduce cash burn through improvements in adjusted EBITDA, working capital management and monetization of non-core assets.
5. Development of the Company’s U.S. THC strategy as permissible under federal regulations.

Commitment to Shareholder Alignment

We want our shareholders to know that the Board of Directors (the “Board”) is committed to delivering on its core principles of shareholder alignment and accountability as we continue to execute on our business strategy outlined in our Investor Day. At Valens, the Board and senior management remain unwavering in our commitment to delivering lasting value for our shareholders and are proud to say we had insider participation in the Financing. Many members of the Board and senior management are shareholders and have also been materially impacted by the fall in share price alongside all shareholders. We want to reiterate that over the last 12 months there have been significant purchases of shares by the Board and senior management, and over this period we have not sold a single share.Asset Monetization

In conjunction with our ‘Integration Initiatives’, we have shifted all production of Citizen Stash products to our highly automated Kelowna facilities to centralize manufacturing and optimize margins. As a result, we made the difficult decision to shut down Citizen Stash’s facility in Mission, British Columbia. We would like to thank all Citizen Stash stakeholders that have built one of the best brands in the cannabis space and assure them that the opportunities for the Citizen Stash brand continue to expand under this new, lower-cost manufacturing structure. We have also decreased the cost of supply by transitioning to new contract arrangements and optimizing the contract grow network. As part of this restructuring, Valens will see a one-time charge which will result in decreased operating expenses in future quarters.  Additionally, we are in the process of monetizing the Citizen Stash’s facility and other non-core assets. We expect to generate an additional $5 to $10 million in cash over the coming quarters which is incremental to the $20 million in annual cost efficiencies expect through 2022.Cost Efficiencies

We have made great progress with approximately 80% of the $10 million in cost efficiencies announced in early February now actioned and the Company is in the process of realizing the initial benefits in Q2 financial results (after accounting for one-time costs), with the majority being expected to be realized in the back half of the fiscal year.

The Company is also pleased to announce it has started to execute plans against the next $10 million in targeted annualized costs efficiencies which are also expected to add a positive contribution to margins in the second half of 2022. The rationalization of the Citizen Stash operational footprint serves as the initial starting point and Valens will continue to provide further updates on the source and timing of further initiatives. For clarity, these annual cost savings are incremental to the initial $10 million in efficiencies that were announced in early February.

Sincerely,

Tyler Robson & Jeff Fallows