Good morning. Welcome to Canopy Growth's second quarter fiscal 2019 financial results conference call. Earlier today, Canopy Growth issued a news release announcing its financial results for the second quarter ended September 30th, 2018. This news release will be available on Canopy Growth's website and filed on SEDAR. On the call this morning, we have Bruce Linton, Canopy Growth's Founder, Chairman, and Co-Chief Executive Officer, and Tim Saunders, Canopy Growth's Chief Financial Officer. At this time, all participants are in a listen-only mode, and certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are made available on SEDAR. During this conference call, Canopy Growth will refer to supplemental non-GAAP measurement adjusted EBITDA.
These measures do not have any standardized meaning prescribed by IFRS. Adjusted EBITDA is defined in the press release issued earlier today, as well as in this period's management's discussion and analyst document that will be filed on SEDAR after the close of financial markets today. Please note that all financial information is provided in Canadian dollars unless otherwise specified. Following the prepared remarks by Mr. Linton and Mr. Saunders, the company will conduct a question and answer session during which questions will be taken from analysts. If you would like to ask a question at that time, simply press star then the number one on your telephone keypad. If you'd like to withdraw your question, please press the pound key. I would now like to turn the meeting over to Bruce Linton. Mr. Linton, please go ahead.
Great. Thank you. Good morning, everyone. I know we're all going to want to talk a lot about what's going on in Canada in the first 30 days. I want to frame what we're talking about, I think, in a bit bigger and more interesting way. We've run through, as a company, the whole startup phase in Canada, and we saw this last quarter was really the ramp-up. I think what you're going to see is there are sort of three six-month segments of how this market's going to go. The first six-month segment is only 30 days old. That it's going to be three sprints which are get out of the gate and get the stores filled, the stores continue to be built out and the products roll in.
The second part of it is going to be to keep up with the channel demand as we enter to the third phase, which is the more comprehensive products. I'll come back to that, but we don't generally give a comment on consensus or analyst numbers because this is such a new sector. All I would say is I don't think analysts were wrong on the target number. I think they were early on the quarter, and that I don't feel particularly concerned that you're way off on the year for our fiscal year. You need to look at the things I'll come back to later as the variables on that. To kick off, really what we've been focused on is the future, in our opinion, is intellectual property and converting cannabis flower into an ingredient and building it up to more value-add products.
We haven't historically talked a lot about the 15 clinical trials that we have planned and structured. I've talked a little bit about the fact that we've been approved and are launching our Phase IIB primary insomnia trial. The animal treatment of anxiety trials have been approved, no objection letters in place, and those are moving forward. That leads to some of the stuff that we've worked on in this ramp-up, which, if you look at the companies that we've either got acquisition agreements with and all the internal work, the number of patents that we have filed and are defending, and we think are quality patents, are about 120. They go across hardware, product formulations, genetics, product innovations, medical treatments. This is not like a sort of one space, one item.
The reason is, I think what you're going to find is as we get into that third six-month sprint for recreational cannabis, that the science that we're talking about here will inform the definition and delivery of those products that will be differentiated. They'll be the ones when we talk about brands that people will actually be able to identify a better product in a specific package with a key name tied to Tweed that will actually be the one that they seek and they'll stay with. That's really the packaging of it. We put something out on October 3rd that I didn't yet get a single question on, which is that the Ontario Long Term Care Association has embarked on a study of how do we make geriatrics life better, which is up to a 500-person study over a six-month period.
The whole point of it is to displace a whole bunch of pharmaceuticals that aren't necessarily benefiting the geriatric and aging crowd to the level of satisfaction of their physicians. They're causing a great deal of side effects that are displeasing their families. That's the sort of thing that I think looks out and says, how do we disrupt really deeply and carry it over? That kind of IP goes to where we're trying to get to with some of our international stuff. Maybe we should put press releases out for things that aren't done, but that's not been our history, and it's not what we're actually going to do. We've had a number of times where we almost got to export to the U.S. under DEA-approved exports, but the paperwork wasn't always easy to get done on this side of the border.
Now we've exported to the U.S. products which are GMP ones, focused on meeting standards so that institutions on the U.S. side can actually use cannabis that's been produced in a way that could become inputs to a decision tree that may or may not result in more comfort with medical and or rec and state rights and things like that. That is a big deal. The whole notion of what's happening with hemp. We have a substantial hemp operation that we've been working on in Canada. We have intellectual property that we've developed around how to manage hemp, and that we thought that was prudent because I think hemp is going to happen in the U.S., and when it does, that's not the time to start. You should have already been started up and ramped up and get ready to revenue up. We think we are.
In that whole world, when we look at what the products are, the single biggest challenge we see in the U.S. is the fact that it's, yes, illegal, but really the claims made on so many of these products are without science. The science, in order to make a valid product, has to be done, and we're working on that. When we swing just over to the Caribbean, we put out a press release indicating that we now have a license in Jamaica. I think Jamaica is going to do a great job of not exporting cannabis, but importing more tourists. That Tweed Jamaica is going to be something, when you're on vacation, you may become officially ill and have access to that product, and it'll make your vacation more enjoyable and the government more money, and everybody a little safer in the process.
The credibility we have in Jamaica has caused us to have an opportunity to export to another Caribbean island, which we haven't named, but we think is the dominoes tipping over through that region. When you think about the number of tourists that will have exposure to brands, so 4.2 million to 5 million tourists in Jamaica, if we can get our brand in front of that cohort on the favorite week of their year, we think that cascades very well back into what they're going to be doing for the rest of the year, which is earning their next vacation and choosing Tweed as their recreational product. When you get down a little bit south of the U.S., our Latin America activities, everything we have down there is structured so that it's 100% ours as we go forward.
It reels in, and we're not in a margin-sharing model, we're in an execution of operations, exporting our intellectual property and cranking up medical outcomes to a very substantial middle and high income class in a region with a huge population. Our activities are principally headquartered in Colombia, but very active and have been for a few years in Brazil and building up our capacity in Chile and as we go down through that area. Quite significant. In both, particularly the Jamaica circumstance, where others have struggled to actually have cash and the ability to move and build, we haven't. We've been able to figure out how to structure capital into the region so that we can actually build out the facilities and be ready to have our stores open. Maybe to come back to Canada.
As far as we can tell, we've been doing daily analysis of data from as many sources, provinces, in stores. Our analysis is that we're about 30% of the available SKUs. I can tell you as an investor, you do not want us to sell only bud and bud forever. Our strategy was and will continue to be, first we launch with our core store bud brands because we think people wanted to walk in the store, buy dried cannabis and conclude that that was interesting, but what they expect is something better and different. Now we've launched our gels, which are soft gels. They are essentially what I think is the Canadian gummy bear equivalent. They're well-structured and will be continuously available. People tried another product at launch and that product sold out.
What they're going to have is the second wave from Canopy, which is going to be sustained, differentiated, and you as an investor will love because it's a much better defendable margin model. The next wave is pre-rolls. Maybe we, in our ramp-up, did something a bit different, but we actually have an engineering department. The reason we have an engineering department is we saw that it's important to actually be able to control our intellectual property, not share margins with people into the future and not get in a circumstance where we couldn't continue to build better and bigger infrastructure for every circumstance that we needed. Our pre-rolls are created on an equipment set that meet the really tight and specific standards of weight per roll and the volume that we expect to put through. That's our IP.
Part of it is, if you're at all interested in history, when you look at how the cigarette market worked, owning the intellectual property around creating cigarettes turned out to be a pretty good thing. We think we're in a good spot with that. As we go down, there are only a handful of stores open in Canada, and every week there's trying to be more. Where we thought it was prudent to focus was on the stores that are open with salespeople that can be trained. We've trained over 650 customer service reps for a variety of stores and provinces across the country. Where sales reps can actually differentiate our product, make sure that it's in the right position, make sure that the education's correct so that when you win, it's not a random lottery.
While we appreciate the change in Ontario and think it was prudent to dump the old plan, in the short term, there's nobody you can educate. There isn't necessarily even a wizard on how people make purchases. While we try to support all stores and we know that we can fulfill all our commitments, our priority is on physical stores and the inclusion of our product where we want it and the inclusion of our gels and rolls as those stores come up. That will, in our opinion, turn into a much longer, more prosperous relationship than being in a random lottery on a website. The inventories are there. We have the gel caps in inventory. We have the inputs and pre-rolls in inventory.
We are in a mode where everything we're trying to do will feed into good science turns to good products to turns to good outcomes. I do think you're going to see as we go through the first six months sprint, that the revenues come up. Don't forget about the rest of the world. I saw this announcement that Malaysia is contemplating covering medical cannabis as probably one of the three biggest announcements in the history of our sector. I'm not sure that it got pickup to the level that would make sense for the first country of that origin and region to say that they're thinking about medical rather than thinking about it as an illegal, threatening marijuana product.
It goes from what I mentioned at the beginning, when you can actually work with the long-term care and you can start to see regions of that sort of world evolving their perspective, the rate at which this market grows is going to be gigantic, and those with the best science, the best brands are going to win. Tim will describe some of the numbers we used for our ramp-up, but I'd say get ready for revenue up as well. Go ahead, Tim.
Thank you, Bruce, and good morning, everyone. I think the key takeaways today are, one, we had strong double-digit medical cannabis sales in line with management expectations. Two, strategic acquisitions and investments have further strengthened our IP capabilities, critical to our long-term success. Three, we are well-positioned for a strong start to the recreational cannabis market in Canada. Four, as Bruce outlined, we are building a strong presence in key international markets. I'll now proceed with the review of the second quarter. Revenue for the second quarter ended September 30th was CAD 23.3 million, representing a 33% increase over the same quarter last year. Revenues in the second quarter were in line with management's expectations leading into the opening of the recreational cannabis market.
By intention, the company made limited test shipments amounting to CAD 700,000 in order to test supply chain systems and logistics before the launch of recreational cannabis on October 17th. Volume sales into the recreational channels did commence after the quarter end. In the three months ended September 30th, 2018 and 2017, oils, including softgel capsules, accounted for 34% and 18% of product revenue, respectively. The total quantity of cannabis sold during the three months ended September 30th was 2,197 kilograms and kilogram equivalents at an average price of CAD 9.87 per gram, up from 2,020 kilograms and kilogram equivalents last year, which were sold at an average price of CAD 7.99 in the same period last year. The higher average price was due primarily to the change in the product mix, including the increased sales of oils and gel caps and higher-priced strains, as well as sales into Germany.
The average price per gram sold in Germany during the second quarter was CAD 13.58 per gram. We have and continue to invest significant effort, capital and resources in activities and programs to ready the company to participate in and lead the Canadian recreational cannabis market. These investments continue to cover the company's entire business operations, including production, fulfillment, marketing, sales, and general administration. In the second quarter of fiscal 2019, the company harvested 15,217 kilograms, with close to two million sq ft of greenhouses in B.C., Quebec, and Ontario licensed recently, including 1.1 million sq ft licensed in early October, to bring our total licensed platform to 4.3 million sq ft. We expect the amount of cannabis harvested to increase in the coming quarters. Turning to gross margin.
The cost of sales includes the impact of operating costs of subsidiaries not yet cultivating or selling cannabis, including our BC Tweed and Mirabel facilities that were only partially licensed in the quarter, as well as higher overheads incurred while preparing operations for the legalization of recreational cannabis, and the diversion of growing space in Smiths Falls to creating clones for transfer to the company's other growing facilities. Excluding the costs associated with non-cultivating subsidiaries totaling CAD 7 million, the gross margin before the fair value impacts on cost of sales and other charges would have been CAD 13.6 million, or 58% of sales.
During the quarter, the reported fair value changes in biological assets and other inventory charges, or other charges, netted to an expense of CAD 40.6 million and included adjustments to net realizable value of inventory targeted to the recreational market, which reflects wholesale pricing, and to a net write-off of approximately CAD 16 million related to plants culled in the quarter due to timing issues with respect to having infrastructure ready for licensing and receiving those harvested plants. Since then, the required infrastructure has been completed and the licensing since received. Turning for a moment to operating expenses in the second quarter. As has been highlighted previously, the company continues to make significant investments across all areas of our business to strengthen the company's leadership position in the Canadian and global medical cannabis markets, as well as in preparation to lead the recreational cannabis market.
Sales and marketing expenses include costs associated with the development of branding, marketing, and education campaigns, the development of new permitted product SKUs, the development of recreational product packaging, the development of cannabis retail and education programs, as well as costs associated with the company's medical outreach program. These expenditures represent the company's view that strong brand recognition is, over time, essential to the company's successful market share acquisition strategy, particularly in the new recreational market in Canada. These costs represent a strategic upfront investment, which management believes will have a long-term benefit in customer acquisition and retention. The company is making these investments to aggressively seek new domestic and international business opportunities to build for the future.
Sales and marketing were up significantly relative to the same periods last year for the purpose of being ready for the future state recreation market, while at the same time developing international markets. Sales and marketing expenses for the three months ended September 30th were CAD 39 million, or 167% of revenue. A big investment. During this period, we launched our national Hiku Media campaign, which included digital placements across Canada, brand activations in communities from coast to coast, and content creation, including for the tweed.com website and marketing automation platforms and developing competencies in retail. In respect to government regulations, all non-age-gated properties were removed on October 16th, 2018, prior to the Cannabis Act taking effect. The company has continued to invest in age-gated channels for both media and experiential marketing across all brands in adherence to C-45 guidelines on promotion.
In comparison, sales and marketing expenses for the three months ended September 30th, 2017, were CAD 7.6 million, which was then a purely medical market. G&A expenses for the three months ended September 30th were CAD 37.1 million. Of note, the second quarter fiscal 2019 G&A included a provision for excess office space in Montreal, which is no longer occupied, and that amounted to CAD 4.2 million. In comparison, G&A expenses for the three months ended September 30th last year were CAD 8.4 million. Acquisition-related expenses for the three-month period ended September 30th was CAD 3.2 million.
These expenses related to acquisitions of Hiku Brands, as well as the unowned shares of BC Tweed and Canopy Health. In addition, costs were incurred due to the ongoing evaluation of potential acquisitions, building a pipeline of M&A potential targets, and reflects increased legal, accounting, and strategic business consulting services required to complete or evaluate these potential or completed transactions. We are likely to acquire additional strategic assets in the future as we pursue our business strategy and as we communicated previously following the strategic investment by Constellation. The non-cash share-based compensation expense related to options granted to employees and consultants of the company and to acquisition-related milestones combined for the three-month period ending September 30th to CAD 99.6 million, of which CAD 50.7 million was related to acquisition milestones. In practice, all employees of the company receive stock options as part of their compensation package.
Acquisition-related milestone payments based on future performance and related criteria have been treated as stock compensation expense instead of being allocated to the purchase price. In comparison, the non-cash share-based compensation expense related to options granted to employees and consultants of the company and to acquisition-related milestones combined in the same period last year was just CAD 7 million. Now, I will turn my attention to other expenses and net income. Other expenses of CAD 115.7 million are primarily made up of fair value changes on financial assets and financial liabilities, the majority of which is non-cash.
The amount was primarily made up of changes in the fair value of the senior convertible notes due to marking to market, which saw the trading price of the convertible notes increase from about CAD 102 to CAD 149 per unit at the end of the first quarter to the end of the second quarter and resulted in an expense of CAD 223.4 million on the revaluation. This loss was partly offset by a gain amounting to CAD 62.7 million related to the acquisition of Canopy Health Innovations and gains totaling CAD 48.2 million, driven mostly by fair value changes on the TerrAscend warrants of CAD 44.7 million. The CAD 115.7 million in other expenses described above accounted for CAD 0.52 of the reported CAD 1.52 loss per basic and diluted share in the quarter, compared to a net loss of CAD 0.01 per basic and diluted share in the comparative period last year.
The after-tax net loss in the quarter, inclusive of non-cash share compensation expenses, fair value impacts and other expenses as just described, amounted to a loss of CAD 330.6 million or CAD 1.52 per basic and diluted share and compared, as I said, to CAD 1.6 million or CAD 0.01 per basic and diluted share in the same period last year. Next, I'll touch briefly on the supplemental non-GAAP measure, adjusted EBITDA. Adjusted EBITDA is defined as earnings from operations as reported before interest and other expenses, tax, and adjusted for removing stock-based compensation expense, depreciation, and accounting for biological assets and inventory, and further adjusted to remove the acquisition-related costs. We report adjusted EBITDA, believing it is a useful financial metric that will help investors assess the operating performance of our business before the impacts of investments, acquisitions, income taxes, and fair value measurements.
Adjusted EBITDA in the second quarter of fiscal 2019 amounted to a loss of CAD 57.7 million compared to an adjusted EBITDA loss of CAD 4.8 million in the same period last year. We believe our deliberate and ongoing investments in building the company's production platforms, brands, international reach, partnerships, and operations, which directly impacted our adjusted EBITDA during the period, is necessary to strengthen the company's global leadership position. Now turning our attention to the balance sheet and cash flows. As of September 30th, 2018, the company's cash and cash equivalents totaled CAD 429.5 million, obviously before the CAD 5 billion was closed on November 1st. This represents an increase of CAD 106 million from March 31st, 2018.
The increase was principally due to the issuance of CAD 600 million in convertible notes in the first quarter, offset by investment in the expansion of our production assets, strengthening corporate capabilities, brand-related campaigns, and the establishment of physical retail stores in Newfoundland, Manitoba, and Saskatchewan. The working capital deficit reflects a reclassification of the convertible notes after giving effect to a tender offer on the notes triggered by the investment by Constellation. The value of the liability reflects the fair value changes in the debt. The tender offer was made on November 2nd and runs to December 5th. As of today, no one has submitted the notes for conversion, but some may choose to do so before the tender expiry date. If any are submitted, the company intends to pay cash instead of issuing shares. After December 5th, any unconverted notes will revert to its prior long-term debt status.
Inventory at September 30th amounted to CAD 150.4 million, up from CAD 101.6 million at the end of March 31. At September 30th of 2018, biological assets amounted to CAD 20.7 million, up from CAD 16.3 million at the end of March 31. Together, inventory and biological assets totaled CAD 171 million at September 30th, up from CAD 118 million at the end of March. Inventories are continuing to be scaled to meet management's expectation of market demands, including demand from the legalized recreational market. By September 30th, inventory quantities amounted to 31,214 kilograms of dry cannabis, 21,499 liters of cannabis oils ranging from concentrated resins or refined oil to finished oil, and 1,497 kilograms of softgels. In comparison, at March 31, 2018, we had 15,726 kilograms of dry cannabis, 6,969 liters of cannabis oils, and 356 kilograms of capsules.
Management continues to believe that significant demand will develop for cannabis oil and, in particular, softgels in the recreational market. As such, the company continues to increase inventories of extract-grade dry cannabis held for conversion and increase the quantity of cannabis oil and softgel caps that we have on hand. Of interest for primarily analysts on the share count as of today, we had 337,362,196 shares outstanding. With the warrants, options, and RSUs, the fully diluted share count is, as of today, 518,386,356 shares. Bruce, this concludes my review of the financials for the second quarter, and I'll turn it back to you for some closing remarks.
Thank you, Tim. I think, I bet there are some questions, we might as well advance straight into those.
At this time, I'd like to remind everyone, in order to ask a question, please press star followed by the number one on your telephone keypad. We ask our analysts to please limit yourself to one question with one possible follow-up question. If you have additional questions, you are welcome to reenter the question queue. Our first question comes from the line of Tamy Chen from BMO Capital Markets. Go ahead, please. Your line is open.
Thanks. Good morning. My first question is on the U.S. market. It's looking like the Farm Bill for CBD may come first before the STATES Act for federal decriminalization. My question is, if so, could you talk a bit about what your initial strategy into the U.S. may be under the Farm Bill?
Yeah, sure. I'd mentioned earlier in the call, we have been hemp farmers for this past summer and busy on the processes related to drying and the potential for extraction and scaling a bunch of IP. That results from an acquisition that we announced probably a year ago for some parties that had substantial hemp experience. We think a lot of that will carry over. What we want to do, though, is recognize that when hemp becomes convertible to CBD, that, I suspect, will cause the effective price of CBD to go to an extremely low point. It's really going to be about the science of converting it into outcomes.
And so things like the clinical trial we're running on how do we make dogs less anxious will have, I think, implications on how do we make geriatric adults less anxious and products that will be registerable with actual claims based on science. And so really what we're looking at is what do you turn CBD into versus how do you farm it, despite the fact that we think we'll probably need and be in the farming and extraction business as well. And so I think we're well positioned with the resulting products that you'd want to begin to launch that actually use CBD in an effective fashion versus making claims that we see in the market in the US right now that are unvalidated.
Things like the clinical trial we're running on how do we make dogs less anxious will have, I think, implications on how do we make geriatric adults less anxious and products that will be registerable with actual claims based on science. Really what we're looking at is what do you turn CBD into versus how do you farm it, despite the fact that we think we'll probably need and be in the farming and extraction business as well. I think we're well positioned with the resulting products that you'd want to begin to launch that actually use CBD in an effective fashion versus making claims that we see in the market in the U.S. right now that are unvalidated.
Yeah. I think Europe is actually the most, or almost the most exciting activity going on. We've been busy in Germany. I think we've been sending product there for, I guess, approaching 2 years. We have been educating physicians and pharmacists with our spectrum educational package. I think we've had about 1,000 pharmacies in Germany move our product, and we're now in the process of seeking approval for upgraded formats of the product. We have plants in the ground in a couple of countries in Europe already and greenhouses. We have unannounced activities tied up in some of the emerging locations because they're not material, we didn't announce them, and we think that what we found over the years is everything we announce is a good idea and everybody tries to follow it.
Our preference is now that we're executing before announcing, and it'll become evident what we're doing. Really, most of the places want proven medical outcomes. They're not just looking for a medical ingredient, which is essentially what it's classified in. I think a lot of the work we're doing has been thoughtful in the trial design that result and the methodologies would be, at least on an expedited basis, able to be introduced into the other geographies as evidence. We're liking Europe a lot. We like the fact that the payer is often the government, and the population seems to be somewhere in that sort of 400 million-500 million, depends who you want to roll in, including the U.K. right now. We've been quite busy there.
Got it. Okay. Thank you.
Your next question comes from the line of Martin Landry from GMP Securities. Go ahead, please. Your line is open.
Hi. Good morning.
Morning, Martin.
Bruce, you mentioned that your SKUs obtained, I think, 30% of listings in physical stores nationwide.
Well, 30% of the currently in-stock inventory nationwide.
Sure. Meaning as of yesterday, or?
As we've been sort of running up, it's sort of hovered 25%-30%. Yeah, what our expectation was is that people might take things away from the medical world, push everything into the rec world. As it sells out, they don't have things for either market. That was not our strategy. We want it to be like a sustaining winning race rather than a flash out of the gate.
My question was more, there was a limited number of stores operational even today. I find it would be probably a little bit more helpful if you can talk maybe about your market share in Ontario, the largest market, in October, how you fared.
When we looked at it, we really had to be polite about the prior plan, which was to have almost no stores, call them 35 in a population of 7 million people where there's over, I think, 800 liquor stores. When you're in the sector, you say that's a good idea because it's improper to say it's a bad idea to the government. It was a bad idea. When they then said, "We're flipping, and we're going to have the private sector create a lot of stores," that actually is a good idea. In the interim, where it's a website where you can't actually affect anything other than you put it up and somebody buys it and it sells out, was it the right stuff? Did they make a good decision? Is shipping going to be reasonable? We've been pretty up the curve on Ontario.
I think the first place the OCS came to learn about cannabis was the Canopy store. In our business, I should say, in Smiths Falls. It was our view that if they were successful in selling on the web, they would be unsuccessful in fulfilling because it is a very different business, B2C than it is B2B. It took us four years to ship a million packages, and they will have to ship a million packages in 30 days, probably. We didn't push the OCS. We supported them, but where our push has been is where the physical stores are. It's been very intentional, and we'll continue to add to what they have there, but it hasn't been our biggest priority to have the most product and push in Ontario.
I think physical stores like Alberta, Quebec, for sure, New Brunswick, Newfoundland, those jurisdictions have been where we pushed as hard as we could.
Okay. If you would have to pick a market share that you think you've achieved so far in the rec market, can you give us some sort of order of magnitude for us to work with?
We've gone 30 days of launch where there were almost no stores, as we've discussed. There were only websites in some places. What we're looking at is how do we sustain our delivery? How do we differentiate our products, and how do we migrate people from buying bud to buying formats that actually make us all more margin? I think when you look at that over the 90-day period of Q3 for us and over the fiscal balance of the year till the end of March. We stated our goal is that we'd be disappointed if we had a 30% share, but we're working for that as the minimum. I don't think we're in a spot where we have the limited resources of cannabis or the limited formats. I think we're going to be durable and get there. That's the revenue up opportunity.
Okay. Just finally, do you have any bottlenecks internally that could prevent you to attain these numbers at this point?
Sure. Every day there is a different bottleneck. I would suggest that they're more less of an issue. Things like applying those damn excise stickers was a bottleneck because they didn't want to apply to certain things, and we were running short runs, which meant we couldn't put as many packages through. I would say with our engineering and operations team, we feel like we're actually getting moving. Maybe the mental image is watching. We talk internally about watching the races where Usain Bolt would always win, but he didn't start off leading because he had to get the momentum going. We feel we're in a bit more like that mode. Moving around bottlenecks, that's why we have internal resources to run all of these things and not outsource.
It feels like we're in very good shape to deliver the product, fill all the orders, have all the formats. It's feeling like a very solid position.
Okay. Thank you.
Your next question comes from the line of Vivien Azer from Cowen. Go ahead, please. Your line is open.
Good morning.
Good morning, Vivien.
Thanks. Good morning. From a high-level perspective, I'm going through my model, and I'm hard-pressed to find a quarter over the last four years where your revenues declined sequentially. Yet the first quarter where you're ramping into adult use, which I appreciate happens in waves and whatever, lots of kind of fits and starts as the market transitions. I'm hard-pressed to understand how you guys posted a 10% sequential decline in revenues. Help us understand that, please.
Sure. Really, there was no product shipped. Functionally, what we were doing was stress testing the system at a request with all the provinces so they could actually make sure their barcodes match with our board, their scanners match with ours. Really there was, call it no revenue shipped to the provinces. With all the hubbub around it, what we saw was a bit of a distraction, we think, in our medical customers and a couple of hiccups in terms of getting the normal run rate to Germany in terms of permitted exports and the product approvals and things getting across. I'd attribute half of the decline to just not normal course Germany, and a little bit of a pause with the medical people.
That said, once rec happens, I think we're going to see an uptick in truthful conversations at doctors' offices because before rec was available, if you said to your doc, "Don't really like the side effects of my RA medication," they might look over their glasses at you and wonder if you just wanted to party. Now you have that choice, and when you have a doctor discussion, I think people are going to be more transparent. We'll see over the next couple of quarters, but I think you're going to see a strengthening of the medical business. Germany, I think we're now back on normal track. Yeah, it is the first time in our history that I'm aware of, where we actually had a slowdown, but I think it was more of a distraction than a pattern.
Okay. To follow up with that, please. Given your commentary on consensus, and despite the fact that we were materially below consensus, you came in below both our estimates and the street. I think it would be prudent for you guys to comment on the cadence of revenues for the back half of the year, please. Thank you.
Yeah, I think most were expecting that the provinces would be taking product in a material way. As you look across the entire sector, the provinces were not ready to take product, then it became urgent, and it remains urgent on the product shipping. When we look at it, I think the other way I opened it is I said you were early on the anticipated volume, but I don't think you're materially wrong on, and I can't comment on every individual, but as we look across the general group, on what the year could look like for our fiscal. I think we're starting to slide into the model as you're thinking about it. We tried to signal on September 27th that we were not shipping to provinces other than stress testing, I think, was the exact phrase we used.
Now it's crank time, and it's feeling like the provinces are starting to get their momentum as well.
All right. Thanks. I'll jump back in the queue.
Your next question comes from the line of Oliver Rowe from Scotiabank. Go ahead, please. Your line is open.
Good morning. Thanks for taking my questions. You touched on it previously, but with the Constellation deal closed now, could you just elaborate on your capital allocation plans, how you plan on putting that CAD 5 billion to work, and how you measure return on that capital?
Sure. We've been going through with our new board and with Constellation. We have a roster of elements we might wish to acquire, none of which are producers in Canada. There are a number of technologies that we think make sense that are out there on a global basis. That, depending on the mix of cash and shares, would probably nibble up close to CAD 1 billion of things that we look at. I'm not saying we're pulling the trigger on all of them. We're also building out a capacity to have a bottling line, which is now finalized and designed, and site preparations have commenced. We think beverages will be a format of product that makes sense under the regulations of Canada. There's no certainty, but we think that could be ready for Q4 calendar 2019. That adds up a little chunk.
What we're trying to do is be ready, as one of the callers talked about, the crank in Europe is significant, but hemp in the U.S. could be sooner than you think. We're going to have some dry powder ready to go, rather than reacting and looking for capital and structuring that, we will be instantly in. That build-out won't use it all, but the first CAD 1 billion we certainly have a plan on. I don't know if Tim wants to comment more. We've certainly looked at our IRR models, and we've become a lot more disciplined in NPV and the way we structure our acquisitions. From a money management perspective, it's been quite remarkable, the cash that wish to be money managers. I don't know if you want to speak to that, Tim, or further comment.
Certainly the kind of transactions that we're looking at in the future, these are cash generating businesses or fit strategic niches or needs that we have in the company so that they lend themselves to more traditional ways to value these things, as opposed to some of the M&A activity in the first couple of years of this industry, where there was an unknown future, unknown predictable cash flow. There's a lot more rigor around our ability to evaluate these investments. They run through the traditional valuation models to make sure that we're covering cost of capital and generating good returns. Most importantly, adding to the strategic need that we need to build up this business.
That's good color. Thanks. We start to see companies locking in retail leases in Ontario despite ongoing policy uncertainty. Have you made any headway on figuring out your strategy that could get you into the Ontario retail market? How do you sort of see that playing out?
The rules haven't been printed yet. Really, it's going to come down to certain definitions. We would be quite fine with the locations which we have under, I'll call it, control, that they became franchises. That maybe they're operated by others, but they carry our brand. Really, for us, retail does give you a little bit of torque, but you have to sell into the warehouse for the province and then out to retail. Data is critical. What's moving, what's not moving, what are the points of education that are causing an up-sale. We want to be able to have access to data as our primary driver, and we think we have a lot to trade in that process. We do expect to have somewhere between one and four licenses granted to us if it's based on licensed production sites.
We have four in the province.
Got it. Thank you.
Next question comes from the line of Mike Hickey from Benchmark Company. Go ahead, please. Your line is open.
Yeah. Hey, Bruce, Tim. Congrats on the quarter, guys. Thanks for taking my questions. I guess congrats on the October launch as well. It's a big event, obviously. I guess it sounds like you're prepared to sort of map some pretty big resources to the U.S. here, probably sooner than most people expect with hopefully the passing the Farm Bill. I guess, just how big do you see the CBD market in the U.S.? Because it seems to be exploding here, mostly anecdotal, but I'm just sort of curious, the math behind your intent to probably take a big move to the U.S. I'm also wondering, as you think about building brands and products around CBD in the U.S., if there's a natural extension to recreational cannabis or medical cannabis down the road once we have the appropriate federal guidelines in the U.S.
Yeah. It's a bit of a touchy one to answer because we're still with our weekly updates on what's going on with [GR]. It's hot, it's cold, it's hot, it's cold, but right now the indications are Farm Bill's hot. Get it done. CBD, I think as an ingredient, can be very disruptive across everything from anti-inflammatory scenarios. Whether it's sports drinks to other scenarios of that nature to, we'll call it anxiety modification or management. It's going to come down to who gets the data to get the branded product that actually works. I think we're doing a very good job on that, and I believe we have a leadership position on that. How big is the market? Is it going to be fragmented? Will they allow interstate commerce with CBD? What's going to happen with all the adjacent THC, right?
The definition of hemp is it has 0.3% or less THC. If you think about how many hundreds of thousands of kilograms of CBD are going to be extracted from hemp, multiply that by 0.3 and you end up with a lot of THC. We have the right to use that THC in scientific endeavors. There's a whole bunch of adjacent elements to that whole hemp discussion, and we haven't actually factored in any of the utilization related to disrupting cotton and things like that. To us, that's somebody else's business. Maybe it's a saleable product, but the segment could be huge. The form factor of what you feed into an extractor as hemp is just really not a whole lot different than marijuana for THC. I think you'll see a value of moving early and getting really good at extraction as a preparatory step.
You may see overspend to be extremely well-positioned, but I don't think that'll be unrewarded.
Okay. Thank you. That's helpful. The second question from me is, how you think about second half calendar year 2019 and the legalization of edibles and concentrates, if you expect a smoother launch or share expectations, et cetera. Onto that, just any updates, I guess, on your work with cannabis-infused beverages in terms of onset, duration, if you've had some success there. I guess how you think about the market opportunity for infused beverages beyond the dispensary. Because at least in the U.S., Colorado or Washington, you have the brand's products, but it remains a rather niche market, and you wonder if it's just trapped in the dispensary where it's really hard to justify, I think, for a lot of retailers to keep shelf. Your thoughts, I guess, on the small basket of questions would be appreciated. Thank you.
I think the two parts were, what about ingestibles? Because I don't think it's going to be just edibles in this second half of 2019. I believe no matter which government's in power, their objective will remain consistent, which is they're not going to hold back this program because it's going to be about diminishing criminal returns and the returns on vapes and ingestibles are very good. I'm reasonably confident they will for sure stay the course on that launch, and then it'll be questions as to what evidence do you have of efficacy, safety, et cetera. Our governors in every province or state are the liquor authorities, and I think, if you come to Canada, you'll find that they principally sell beverages which are shelf-stable and nothing else. Their comfort with that form factor, I think, is going to be very high.
The second part, though, is, yes, we have been working on bioavailability, flavorings. We have worked with Constellation on branding, analytics of who wants what when. There's been a lot of work on beverages, and the fact that they have any share in most of the U.S. markets surprises me because, mostly what we focused on was what's wrong with the products that exist, which is takes too long to onset, has too much in it for duration, and generally, isn't a particularly appealing beverage in terms of coloration or flavor because there's a lot of masking agents. I think our researchers have done a good job, and I think Greens tar, which was the Constellation division, spent money well to look at where we need to hit.
When I left our facility on Monday, we were clearing and preparing the site where the bottling line will be, and it has a schedule for construction that I hope we'll just stay on and see it complete sometime in May as far as the actual structural building. I think we're lining up the governance model, the product and the production. Stuff could go wrong, but I don't think anyone else is in the same space, thought process or position at all as we are.
All right. Thanks, guys. Best of luck.
As a reminder, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. Your next question comes from the line of Graeme Kreindler from Eight Capital. Go ahead, please. Your line is open.
Good morning, gentlemen. I was just wondering, can you please elaborate on the strategy, in terms of meeting and keeping up with growing demand in medical markets domestically and internationally on top of how you characterize it as sprints in the recreational market, how the company looks to stay ahead of the curve on all three of those?
We're running, Tim, correct me if I'm wrong, I think we're at about 4.3 million sq ft of approved production assets, which do include the capacity to extract and things of that nature. We have about another 1.7 million-ish sq ft that we think is ready for and generally should be approved almost. Some of the buildings still, small portions in, say, New Brunswick or Newfoundland aren't at that stage, but we're talking 100,000 or 200,000, 300,000 sq ft of that. We have in our ops curve and our commitment to medical patients was that if you're a patient on July 1, when it was announced, we'll always have the product for you.
What we map out is what does the market look like for medical, what's the form factor for medical, which is shifting, as you can see in our price point to increasingly gels. Our production up in Denmark and some of the products that we have being harvested down in Spain, we're focusing on how do they meet GMP or GAP practices so that they could actually begin supplementing our domestic production in Canada for product markets in Europe. That combination sort of looks like it works quite well to get through the target revenues that we have. It does need to work, but it's not all new to us.
The practices that we put in in places like Spain and Denmark borrow quite a lot from what we've learned over four or five years of running greenhouses are the first operator in Canada. It feels like it's going to work, it's going to come down to form factor, but the shift to oil seems to be quite steady.
Okay, thank you.
Your next question comes from the line of Vivien Azer from Cowen. Go ahead, please. Your line is open.
Great. Thanks for the follow-up. Bruce, I appreciate your strategy on focusing on brick-and-mortar stores versus e-commerce. I'm having a hard time reconciling that commentary with the continued inventory build when, a province like Quebec is so tight on supply that they're closing their doors three days a week. Help me.
Yeah
square that circle.
I think, if you look at Quebec and who's showing up with product, we're increasing our position in what we're fulfilling. I wouldn't necessarily attribute their absence of product to us and increasingly not. The first province in which we put our gel caps was Quebec. We think that if they open and they keep scarcity happening in our products there, it's going to do quite well. It's not all perfect, right? Everything's not balanced yet. It's a six-month window. That's the sort of shift where we're doing it. I think they'll have a time where they start opening their doors more, and then the products they have represent more and more of us. Quebec is Exhibit A why we actually chose to put our gels there first.
Okay. That seems reasonable. Just as a follow-up, pivoting to Ontario, you've got an e-commerce model only for the next five or six months. Help me think through why that province in particular, given how large it is, doesn't deserve a different strategy.
I think as you get further out, you will see more and more of our product there because I think you're going to find that there's less and less of others and that we support them more and more. We are going to have more and more stores open, right? I don't think the objective of Alberta's 17 stores is a lot more. It's going to be constantly a bottleneck balancing act. The initial order from Ontario was quite small and our subsequent order was quite large. There were bottlenecks for them and that a truck can arrive, but maybe it doesn't get up to the store for seven or eight or 10 days. Those things are all being worked through. You will see more of our product there, but we're talking about the first 30 days out of the gate.
Our view was that people will buy what's ever there. There'll be no limit. There'll be no opportunity to inform them. It's going to sell out from most others, and then we sustain ourselves. It's going to actually reward us with the top-line growth that we want over the three months and six months, not the first 30 days. I just keep an eye on that site. As hard as it is to search stuff, if you've been on that website as much as we have, there are probably 100 things you'd like to fix on that website. I bet they fix them and I bet we show up more.
All right, fair enough. Thanks for the follow-up.
Your next question comes from the line of Martin Landry from GMP Securities. Go ahead, please. Your line is open.
Yes, thank you. Two follow-ups for me. Your gross margin, I think came in around 28%. It was much lower than what we were looking for. I was wondering, when can we expect things to improve on the production cost side? You're getting bigger scale, you're growing greenhouse, which should be lower cost. At what point does your gross margin move up, towards the 60%-70% where it was at some point?
Sure. Go ahead, Tim.
Yeah, no, I think what you're seeing that during that quarter, we went from a 2.3 million to 4.3 million sq ft of licensed space. During that time, there was still a lot of underutilized capacity. I guess we're now up to 4.3 million sq ft after the most recent license upgrade in October. You're going to see more utilization. You've got approximately almost 4 million sq ft of greenhouse space between Niagara, Mirabel, and BC Tweed. Once those are fully producing, you're going to see the higher utilization of that space and you're going to see a drop in cost of production. What we're seeing is a period of transition, getting these facilities ready to produce and, those costs are flushing through right now in the P&L, but those will be behind us.
Yeah. Martin, I remember when you think about all the additional licenses granted, that was exciting and good news. What it meant, though, is much of Smiths Falls had to be turned into a clone factory. Now the clones are everywhere. They're propagating out at those locations and we convert back into the primary purpose for the Smiths Falls facility, but you also get the yield off the other one. In this past quarter, you saw quite a lot of that going on.
If I hear you well, Q3 we should see a nice improvement on your gross margin line.
Yeah, it starts improving. At the initial point of rec in Canada, provinces are screaming, "Get me product," which means that you don't necessarily optimize cost. You try to make sure you get them product. Sometimes you might have to put it on a plane. Sometimes you're running a lot of overtime. We're finding that that craziness for the first 30 days is now starting to become a predictable, more reasonable model, and we can actually start and really look at how we run the business versus how we satisfy the end of prohibition. I think you'll find that as we go through the quarter even, we really start locking down on that.
Okay. My last question is, you had a marketing campaign, a national campaign with your Hi. logo. Wondering, do you have any data point you could share in terms of brand awareness or clicks that would help us understand a little bit how much traction your brand is getting?
Yeah. I don't have that right at my fingertips, but we're talking about it because in major markets, up until the night of the 16th, we ran really effective pop-ups, meaning engagement in community, billboards, and systems that put Tweed front of mind further. Then we had to take them down, and we did not receive a letter from Health Canada to say that we were not in compliance because we actually took things down and ran them properly. Now, if you go to a social event, whether it's perhaps in a bar, which is 19 and over, you will see a stage backed by Tweed, and you'll see bathroom posters where it's in those little steel frames. We're staying in compliance, and we're actually seeing quite good traffic engagement, particularly on social media where people are posting up. I don't have the exact click-through data.
I'll make sure for the next call to you.
Okay. Thank you.
That concludes the Q&A portion of today's call. I'd like to turn the call back over to Mr. Bruce Linton for some closing remarks.
I think we've covered everything off, and I will get now to explaining it to on CNBC and CNN and other locations in New York. Thank you for your time, everybody.
This concludes Canopy Growth's second quarter fiscal 2019 financial results conference call. A replay of this conference call will be available until February 12th, 2019, and can be accessed following the instructions provided in the company's press release issued earlier today. Thank you for attending today's call, and enjoy the rest of your day. Goodbye.